What inflation means for your money – from mortgages and savings to pensions

UK took a surprise dip in December, providing “timely respite” for Chancellor amid concerns over turmoil in the financial markets.

The rate of Consumer Prices Index inflation fell to 2.5% in December from 2.6% in November, the Office for National Statistics said.

The ONS attributed December’s slight drop to lower hotel prices and a smaller increase in tobacco costs compared to the previous year, though higher fuel and second-hand car prices provided some upward pressure.

Most analysts had been expecting the inflation rate to remain unchanged at 2.6% last month. However, December’s headline figure remains above the 2% target level, raising concern for economists and policymakers amid stagnant economic growth.

Ms Reeves responded to the latest inflation figures by saying she would “fight every day” to improve people’s living standards, but noted, “There is still work to be done to help families across the country with the .”

What is inflation?

Inflation is the economic term for the sustained increase in prices for goods and services over a specific period of time.

The goods and services analysed include everything from food and transportation to medical care and are weighted towards households’ most consumed areas.

The Consumer Price Index (CPI), the international measure that examines inflation rates, dropped to 2.5% in the UK in December 2024, down from 2.6% in November.

What does the inflation rate mean for your money?

The rise in the inflation rate means higher product prices and a fall in the purchasing power of money. When general prices rise during inflation, but the value of money stays the same, households can buy fewer goods for the same monetary sum.

As CPI rates report a 2.5% inflation rate in the UK, this indicates that goods now cost 2.5% more than last year.

Alice Haine, personal finance analyst at online investment platform Bestinvest said: “UK inflation eased in December, which may be comforting for consumers hoping for further respite from high borrowing costs.”

However, she noted: “While the better-than-expected figure opens the door for further cuts from the Bank of England, the drop in the headline rate is only expected to be temporary with inflation edging up again in the coming months.”

Economists anticipate a “temporary reprieve” before price rises pick up pace this year due to the Chancellor’s Budget measures. They expect price pressures to build from 2025, with inflation forecast to reach 3.2% in April.

Sanjay Raja, a senior economist for Deutsche Bank, said: “Looking ahead, price momentum will only pick up from here.

“Increases to the National Living Wage and Employer National Insurance Contributions will, we expect, push inflation higher over 2025. Higher energy prices won’t help either, nor will higher food prices, which are starting to emerge.”

Mortgages

While inflation remains higher than the government-set target of 2%, markets still anticipate the Bank of England reducing in February. However, the prospect of rising inflation means the “path remains murky” for many more.

Scott Gardner, investment strategist at digital wealth manager Nutmeg, said: “Policymakers and treasury officials will be breathing a small sigh of relief as new data shows that inflation fell during the final month of 2024, beating market expectations.

“This data will increase the chances that the Bank of England cuts in February, though the path remains murky for multiple cuts this year.”

The average cost of a new fixed-rate has been volatile since the Budget, with some lenders repricing their products to reflect shifting expectations.

Ms Haine said: “With inflation potentially edging up further in the coming months, this would only prolong the pain for borrowers hoping for some respite from sky-high payments.

“For now, borrowing costs remain relatively high, and with the market mired by uncertainty, first-time buyers and existing homeowners looking to secure a new deal soon may be feeling on edge.”

Ms Haine suggested that those looking to secure a new or refinance an existing product “would be wise” to secure the services of an independent broker.

She said: “With the gap between the average rates for two and five-year fixed rates narrowing, and so much uncertainty about future cuts, choosing whether to lock in for a shorter or longer period and whether to opt for a fixed or tracker product will require careful consideration.”

She added: “Any borrowers still fortunate enough to have cheap fixed-rate loans, secured before the Bank of England began its tightening cycle more than three years ago, must brace for a jump in costs when they eventually remortgage.”

Savings

Easing inflation brings mixed implications for savers. While more savers can now achieve a real return on their , have already begun to decline following last year’s base rate cuts.

Ms Haine said: “While the best savings rates still comfortably outstrip inflation for now, that may change if inflation edges back up again. Locking in the best deal possible while rates remain on the higher side can be an effective inflation-beating strategy, particularly for those with cash languishing in an account delivering dismal returns.”

Savers with large balances at risk of tax on interest should consider using ISAs and pensions for a more tax-efficient strategy.

Ms Haine added: “With increasing numbers of people now paying higher rates of tax because of frozen or cut personal tax thresholds, taking advantage of tax-free allowances will become even more important as we near the end of the tax year.”

Pensions

Ms Haine suggested that savers considering annuities “are one cohort to benefit” from recent market volatility.

Annuities, which provide a guaranteed annual income in exchange for a lump sum, fell out of favour during the low-interest-rate era after the Global Financial Crisis.

However, with annuity rates tied to bond yields and expectations, the ongoing pressure on gilts means pension savers may now find significantly improved deals available.