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Guide to inflation

October 9, 2023
The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article.

The dark shadow of inflation has become very much a part of everyday living in 2023. It seems essential to not only budget for the short-term, but also for long-term finances.  As much as we tend to be focussed on the here and now, it is important to consider future finances such as savings, investments, and pensions. In order to understand what we need to do to ensure our savings perform, we must understand what inflation is.

What is inflation?

In simple terms, inflation is a reflection of how prices have risen over a specific period of time. This could be as a result of higher demand, production or service costs, or other factors to do with politics, for example. Inflation impacts all areas of the economy, such as goods and services, tax rates, interest rates, investments, etc. Essentially, when something increases in price, the value of your money decreases – you are getting less for your money.

For example, if the price of your favourite chocolate bar has always been £1, and then it suddenly increases to £1.15, the value of your money decreases because you are getting the same product for a higher price. In this case, the inflation rate is 15%.

How does inflation affect your pension?

Pensions are regarded as one of the best ways to invest your money because, in many cases, there are several factors contributing to the growth of your pension: your own contributions, government tax relief, and employer contributions.

Unfortunately, pensions are not entirely safe from the negative consequences of inflation. Fortunately, in most cases pensions grow faster than the rate of inflation. It is important to understand the intricacies of inflation, and how it might impact you specifically.

How inflation is calculated

Inflation rates are often estimated by comparing the cost of something currently with its price a year ago. It is important the government tracks inflation prices in order to determine how the average UK household is likely to be affected.

With inflation, the cost of living increases. The products chosen for monitoring reflect what the average family will buy and changes in price are recorded statistically by the Office of National Statistics (ONS). The figures the ONS presents is called the Consumer Price Index (CPI) and these statistics reflect the rate of inflation. These figures estimate the average percentage of money spent on typical goods and services purchased by a household. For example, as well as groceries, other products need to be monitored such as petrol, dining out, and tobacco.

Why are we seeing extreme inflation in 2023?

There is no simple answer here, many economists still talk about Brexit, the pandemic, and detrimental governmental deflation techniques. But currently, the main factors all tend to have their origins in the Russia-Ukraine conflict:

  • There are restrictions on the availability of energy from Russia – supply does not equal demand, so prices rise.
  • The conflict has led to a fall in the grain available which in turn, because of supply and demand issues, has led to higher prices.
  • A shortage of vegetables and fresh produce has affected prices.
  • Restrictions on the availability of energy and fundamental food ingredients led to difficulties for business overall, but especially in the hospitality sector. In order to cope, management has had to raise prices, footfall has fallen, sales have fallen, and employment rates have also fallen.

Should salaries be taken into account as well?

The state of income across the UK is important in comparison to the cost of living. If consumers do not have effective income, they are unable to buy from the market.

According to the ONS, in May to July 2023, the annual growth in regular pay (not taking into account bonuses) was 7.8%. While this sounds promising, when you take into account inflation, the average regular pay actually only rose by 0.6%.

How the government tries to slow inflation

This will be dependent upon the national economic presentation, but typically, the traditional method is for the government to raise interest rates. The thinking behind this is it will slow down borrowing, reduce consumer spending, and eventually (as prices will fall to encourage spending) reduce the rate of inflation. To help slow inflation, the Bank of England has already raised the interest rate 14 times since December 2021.

The downside of this technique is businesses cannot borrow in order to thrive. This could lead to a fall in job creation and even redundancies. Mortgages are likely to be affected as well.

How can I protect my pension and savings?

State Pension

Currently in the UK, the State Pension is protected by what is termed the triple lock system. The rate of pension you receive will rise in line with the highest of one of the following three factors:

  • The consumer price index (CPI)
  • Average earnings
  • 2.5%

Defined benefit pension

A defined benefit or final salary pension is a private pension where the amount you’re paid is dependent upon the number of years worked for an employer and your final salary. Your employer pays you a secure income for life which is adjusted each year to take inflation into account.

However, these pensions also have an inflation cap of between 3% and 5%. Clearly, it will struggle to keep up with today’s increasing inflation.

Defined contribution pension

You do not receive a guaranteed amount with a defined contribution pension as it is dependent on the amount contributed to the pension (by you, potentially your employer, and government tax relief) and its performance growth. Defined contribution pensions are more common than defined benefit pensions.

Inflation can affect your final return at retirement in two ways. Firstly, it could affect your investments – if inflation increases, often, the performance of your investments decrease. Secondly, it could reduce the real value of your pension pot when you come to access it. Statistics show us that, on average, investments are likely to beat inflation but it still means they have to work twice as hard just to keep up.

The other problem is that during times of high inflation, people tend to cut back on outgoings and one way to do this is to reduce (or stop) pension contributions. This is not recommended as building a pension is a long-term game where there are likely to be ups and downs along the way. The most important thing is to save money (and with tax benefits there is not a lot of saving methods to beat a pension). When inflation falls, hopefully investments will recover.

Consulting with a regulated financial adviser can help to make sure you know what all of your savings options are, and how inflation can impact your specific pension.


In 2023, inflation is pretty much a global phenomenon. Triggered by events such as Covid, the Russia-Ukraine conflict and Brexit, prices continue to rise. The government measures the increase by monitoring the prices of products considered to be central to the average UK household.

There are many techniques for keeping inflation under control but traditionally the government will attempt to raise interest rates. At time of writing (September 2023), the inflation rate (approximately 6.7%) is stabilising and it is hoped it will be at 5% by the end of 2023.

We also need to keep an eye on long-term savings (such as pensions) at times of inflation, but the good news is investments by default are likely to overcome short term economic issues. However, this is also dependant on how close you are to retiring and how your investment performs overall. Speaking with a regulated financial adviser ensures you are kept informed about the best options for your pensions and your individual circumstances.

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