Inflation Explained: Why Prices Rise (and Why It Feels Worse Than the Headline Number)
“Inflation” is still one of those words that turns up everywhere: budgets, wages, mortgages, politics, supermarket aisles. Yet most people only see it as a monthly percentage on the news— and then wonder why their bank balance feels like it’s shrinking faster than that number suggests.
Inflation is, in simple terms, the rate at which prices rise over time. When inflation is high, the same £10 buys you less than it used to. When inflation is low, prices still tend to rise — just more slowly.
The confusion starts because inflation isn’t one single thing. It’s a measurement, built from a basket of goods and services, and the basket is not your life.
The story turns on whether inflation is mainly a temporary price shock or a slow, self-reinforcing change in how money loses purchasing power.
Key Points
Inflation means prices rising over time, which reduces the purchasing power of money — your pounds buy less.
It is usually measured by tracking a “basket” of common goods and services, then calculating how that basket’s cost changes.
Your personal inflation rate can be higher or lower than the official rate, depending on what you spend most on (energy, rent, childcare, commuting).
Inflation can come from demand (people spending more), supply shocks (costs rising or shortages), or built-in expectations (wages and prices chasing each other).
Moderate inflation can be managed, but volatile or high inflation creates uncertainty, which changes business behaviour, wage bargaining, and investment decisions.
For households, inflation matters most through three channels: wages, debts (like mortgages), and everyday essentials that you can’t easily substitute.
Background
Inflation does not mean "high prices." Prices can be high and stable. Inflation is when “prices are rising. ”.
Think of money as a claim on real stuff—food, fuel, labour, housing, and time. Inflation is what happens when that claim weakens. If your pay rises 2% but prices rise 5%, you are effectively poorer, even if your salary number looks bigger.
Consumer price measures, which track changes in the cost of a representative basket, typically discuss inflation in the UK. This basket includes things many households buy regularly (groceries, transport, utilities), plus services (haircuts, mobile contracts, restaurants). Each item is weighted to reflect average spending patterns.
That weighting is crucial. It means inflation is always a national average of many different experiences. A commuter who drives daily, a renter facing a new tenancy, and a family paying nursery fees can live in three different inflation worlds at once.
Inflation also interacts with interest rates because central banks try to keep it stable. When inflation is high and persistent, rates often rise to cool spending and borrowing. When inflation is weak, rates can fall to encourage demand. That feedback loop is why inflation can suddenly dominate mortgage costs, business loans, and government budgets.
Analysis
The Three Real Causes: Demand, Supply, and Expectations
Most inflation stories can be sorted into three buckets.
Demand-driven inflation happens when spending grows faster than the economy’s ability to produce goods and services. If households and businesses are buying more, sellers can raise prices because customers keep paying them. This often shows up alongside a hot labour market and rising wages.
Supply-driven inflation happens when costs rise or goods become scarce. Energy spikes, shipping disruptions, crop failures, geopolitics, and factory bottlenecks can all push prices up even if demand is flat. This kind of inflation feels particularly unfair because people didn’t choose it — it arrives like weather.
Expectation-driven inflation is the gradual increase in prices. If workers expect higher prices, they push for higher pay. If firms expect higher costs, they raise prices earlier and more aggressively. That can become self-reinforcing: inflation persists, not because one shock continues, but because behaviour changes around the idea that prices will keep rising.
The tricky part is that these causes can overlap. A supply shock can trigger expectations, and then demand adjusts in ways that keep inflation alive.
Why Inflation Hurts More Than It “Should”
Even a moderate inflation rate can feel brutal if it concentrates on the things you can’t dodge.
People can postpone a new television. They cannot postpone heating a home, feeding a family, or commuting to work. When essentials rise faster than the average, inflation feels like it’s targeting you personally.
There’s another psychological layer: humans anchor to familiar prices. A coffee “should” cost roughly what it did last year. When it doesn’t, it triggers a sense of loss and unfairness. Inflation is not just economics; it is a daily reminder that your effort is worth less than it was.
And then there’s timing. Wages usually adjust slowly, often annually. Prices can adjust overnight. Even if pay rises eventually catch up, that gap creates a period of household pressure.
Inflation and Debt: The Quiet Winner and Loser
People often find the interaction between inflation and debt confusing due to its seemingly contradictory nature.
If you have a fixed-rate debt, inflation can erode its real burden over time. You still owe the same number of pounds, but if wages and prices rise, that fixed amount becomes easier to handle — in theory.
However, most households do not operate solely based on theoretical concepts. If inflation leads to higher interest rates, new borrowing becomes pricier, and variable-rate debt can bite immediately. Even fixed-rate borrowers can get hit when their deal ends and they refinance into a different rate environment.
Inflation can also punish savers. If your savings earn 2% but prices rise faster, your money is shrinking in real terms while sitting perfectly still on a statement.
The Central Bank Dilemma: Fight Inflation Without Breaking Everything
Controlling inflation is not about stopping prices from ever rising. It’s about keeping the pace predictable enough that households and businesses can plan.
When inflation is volatile, planning collapses. Businesses become cautious about hiring and investment. Households cut discretionary spending. Long-term contracts start to feel risky because nobody knows what future costs will be.
Raising interest rates can cool inflation by reducing borrowing and spending. But higher rates can also slow growth, increase unemployment, and squeeze heavily indebted households and governments. That’s the tension: stabilise prices without causing unnecessary damage.
What Most Coverage Misses
The hinge is that the official inflation rate is a measurement of an average basket—not a direct readout of what inflation is doing to your household.
The mechanism is simple: inflation is weighted. If the price of something you buy constantly (rent, childcare, energy, insurance) rises quickly, your life inflation can be far higher than the headline number, even if other categories are calm or falling. Meanwhile, the basket itself changes over time as spending patterns shift, and some prices are adjusted for quality changes, which can widen the gap between “statistical inflation” and “felt inflation”.
Two signposts to watch over the coming weeks and months are whether services inflation stays sticky (because wages and expectations are involved) and whether essentials continue to outpace the broader basket (because that’s what drives the squeeze people actually notice).
What's changing now?
Inflation changes behaviour long before changing policy because it changes confidence.
In the short term (weeks), the most significant impact is usually on household choices: trading down brands, postponing big purchases, renegotiating bills, and cutting optional spending. For businesses, it can mean tighter inventory management, smaller pay rises spread unevenly, and price changes that arrive more frequently than customers are used to.
In the longer term (months and years), inflation reshapes contracts and assumptions. Fear of cost lock-in makes employers more cautious about wage deals. Households become more cautious about taking on new debt because they fear refinancing risk. Governments face louder trade-offs because inflation pushes up the cost of servicing debt and delivering public services.
The main consequence is this: inflation becomes socially and politically explosive because it feels like a pay cut that no one voted for, because it arrives as higher bills before pay can catch up.
Real-World Impact
A renter goes to renew a tenancy and finds that the new monthly figure is not just “a bit higher” but structurally different. Their budget doesn’t break in one place; it breaks everywhere at once, because rent crowds out everything else.
A small business owner updates prices for the third time in six months. Customers complain, but margins aren’t rising — costs are. The business feels blamed for a problem it didn’t create and begins to reduce staff hours in order to survive.
A household on a fixed mortgage deal feels fine until the renewal date becomes visible on the calendar. Inflation isn’t the scary part; the uncertainty is, because the future monthly payment is now a guess.
A saver who did everything “right” watches their savings rate lag behind everyday price rises. The number in the account grows, but the real buying power quietly shrinks, which changes risk appetite and pushes people towards investments they don’t fully understand.
The Price of Predictability
Inflation is often described as “prices going up”. The deeper story is about “predictability going down”.
When inflation is stable, people adjust and get on with life. When inflation is volatile, it changes how everyone behaves—workers, firms, lenders, and governments—because nobody trusts the future price of anything, including money itself.
That is why inflation has outsized power in politics and personal stress. It’s not just about a supermarket receipt; it’s about whether the rules of planning still hold.
What to watch next is whether wage growth and service prices keep feeding each other and whether essentials continue to run ahead of the average basket – because that is where inflation stops being a statistic and becomes a living crisis.
Final sentence: The real historical significance of inflation is not that prices rise, but that confidence in tomorrow’s costs can fracture a society faster than almost any headline suggests.
