First, let’s look at interest rates

Simply put, interest is the cost of borrowing money or the reward for saving money. 

If you’re borrowing money, for example taking out a mortgage or a car loan, the interest rate is how much you’ll be charged for that borrowing.  This will be shown as a percentage of the amount of the loan. The higher the percentage, the more you’ll have to pay back. So if interest rates rise, borrowing becomes more expensive. 

If you’re saving money, the interest rate is how much money will be paid into your account for that saving. Again, it’s shown as a percentage - the higher the percentage, the more you’ll get.

You may also have heard of ‘the Bank rate’, often referred to in the news as the ‘Bank of England base rate’. This is one of the things that influences the lending and savings rates offered by banks and building societies, although you’ll see lots of different interest rates once you start to look around. 

What is inflation?

Inflation means the increase in prices over time and, like interest rates, it’s shown as a percentage.

In the UK, every six weeks the Office of National Statistics (ONS) sets the rate of inflation by looking at the cost of around 700 things people buy regularly – everything from bread, petrol and electricity to cars and holidays. This measure is known as the Consumer Prices Index (CPI).

It then compares the total cost of those things to what they cost a year ago. The change in prices is the inflation rate.

The government has an inflation target of 2%.

How do interest rates influence inflation?

Like other central banks, the Bank of England uses interest rates to influence inflation. The theory goes that if interest rates are high, it makes borrowing look less attractive, and makes people want to save. In turn, that means people will be spending less, so prices are expected to rise more slowly and the rate of inflation will be lower.

Conversely, if interest rates are low, the theory is that people are more willing to spend or borrow more. So prices are expected to rise more quickly and the rate of inflation will go up.

But what if both interest rates and inflation rise?

Both going up at the same time means it’s more expensive to borrow and more expensive to spend – something which is happening at the moment. It can take time for interest rate increases to bring inflation down, so we could potentially see rising interest rates and inflation for some time to come.

If you have savings, you might be getting more interest on them, which you can use to support your spending. But if you aren’t, or the interest you’re getting is less than the rate of inflation, this can create financial challenges, and is where budgeting and managing your cashflow is vital.

What to do if you’re worried about interest rates and inflation

MoneyHelper website provides free and impartial money guidance, including tips on budgeting.

If you’re looking for more hands-on support with your finances, you might want to speak to a financial adviser. They can build a plan to help you make the most of your money, now and in the future. There’s likely to be a cost for getting financial advice.

If you have an abrdn financial planner, you can contact them in the usual way. Alternatively, find out more about financial advice from abrdn here.

The information in this article should not be regarded as financial advice. Information is based on our understanding in July 2022.