Inflation is a measure of how much prices for goods and services increase over time. For individuals and businesses, inflation impacts everything from household budgets to long-term economic planning.
The UK sees inflation rise and fall due to various factors. To keep it under control, the Bank of England and UK government change their monetary and fiscal policies to encourage consumers and businesses to save or spend.
While these policies exist to influence inflation, it remains very difficult to predict. That’s why it’s crucial businesses take action to protect themselves from potential damages.
Inflation can significantly affect exchange rates, so understanding the key factors that cause inflation to rise and fall is particularly relevant to UK businesses trading in foreign currencies. By doing so, businesses can plan more effectively, forecast with more confidence, and protect their profits.
In this article, we’ll explore the causes of inflation, what influences it in the UK, the impact it has on businesses, and what might shape its trajectory in 2025 and beyond.
Table of contents
- What is inflation?
- What makes inflation rise in the UK?
- What causes UK inflation to fall?
- What could drive UK inflation in 2025 and beyond?
- What does rising inflation mean for you?
- Conclusion
- 10 FAQs on Inflation in the UK
What is inflation?
Inflation is the general rise in prices of goods and services. When inflation increases in the UK, the purchasing power of businesses and consumers drops.
It’s typically measured through indices like the Consumer Prices Index (CPI) and Retail Prices Index (RPI). These indices measure the average change in prices of a basket of goods and services over time.
Moderately low and, importantly, predictable inflation is often considered healthy for an economy. This is because the knowledge that prices are rising gradually gives consumers an incentive to make purchases sooner, boosting economic activity.
However, when inflation rises too quickly, it can harm consumer savings and strain businesses.
What makes inflation rise in the UK?
Inflation in the UK is influenced by several factors, including policies from the Bank of England, global economic trends, and black swan events.
In October and November 2024, inflation in the UK rose for consecutive months for the first time since autumn 2022. Inflation continued to rise in the following two months, climbing from 1.7% in September 2024 to 3% – a 10-month high – in January 2025.
The October and January increases were largely against economists’ expectations, raising questions about the factors driving this trend and what it means for the future.
Here are the key drivers that can cause inflation to rise:
Energy costs
The UK heavily relies on energy imports, meaning price changes in global energy markets have a significant impact.
Rising oil and gas prices, often caused by geopolitical tensions or supply chain disruptions, can filter through to households and businesses, increasing costs for transportation, heating, and manufacturing.
Supply chain disruptions
Post-pandemic recovery efforts, combined with Brexit-related adjustments, have weighed on UK supply chains.
Labour shortages, customs delays, and higher shipping costs caused by these disruptions have contributed to the rise in price of goods, particularly food and raw materials.
Wage growth
As businesses compete to attract workers, particularly in industries facing labour shortages, wages typically rise.
In certain industries, if some businesses begin to offer higher wages, others may follow suit.
For example, multi-national UK firms may be competing with talent in countries such as the US, pushing up expectations for wages for specific roles. This can be seen in the rapid rise in UK lawyer wages, which have jumped 40% in the past five years.
While higher wages are beneficial for workers, they often lead to increased costs for businesses, which are then passed on to consumers in the form of higher prices.
This can create a wage-price spiral, which sees higher wages lead to higher prices, therefore a demand for higher wages to meet the new prices and so on.
Monetary policy
As mentioned earlier, a major part of the Bank of England’s (BoE) role is to keep inflation steady by adjusting its monetary policy.
In this context, monetary policy refers to Bank Rate or the interest rate set by the BoE. This rate is then used as a base rate for commercial banks when deciding on what rates they’ll offer for things like mortgages, loans, and savings accounts.
When inflation is high, the BoE may increase interest rates to discourage spending by making borrowing more expensive and savings more valuable.
When inflation is low, the BoE may cut interest rates to encourage businesses to make more investments with cheaper loans and consumers to buy new homes thanks to better-priced mortgages, for example.
This increased spending often benefits economic growth, but the BoE must tread a fine line to prevent inflation from increasing and damaging the economy.
Depreciation of the pound
A weaker pound makes imports more expensive for businesses and consumers. Several factors can significantly impact the pound’s value, such as:
Interest rates
Higher UK interest rates compared to other major economies can attract foreign investment, strengthening the pound. Conversely, lower UK interest rates can weaken the pound.
Economic stability
If the UK has strong economic growth, low unemployment, and/or a healthy balance of trade, it may boost investor confidence, giving the pound a lift.
Geopolitical landscape
As a risk-on currency, investors tend to move away from the pound during times of global uncertainty, such as wars, pandemics, and international tensions. When this happens, demand for the pound shrinks, and its value takes a dip.
Market expectations
Investor expectations about future economic and political events play a crucial role. For example, anticipated interest rate cuts can weaken the pound before any official decisions have been made.
Black swan events
Unexpected and unpredictable events like the 2008 financial crisis, Brexit, natural disasters, global pandemics, or unforeseen geopolitical events can significantly and suddenly impact the pound.
Brexit, a black swan event, led to the largest one-day drop in the pound’s history.
When the UK voted to leave the European Union in June 2016, the pound fell by 10% against the dollar. Typically, a one-day movement of 1% between the pound and the dollar is considered significant.
Events like this typically contribute to inflationary pressures as businesses face sudden spikes in the cost of their imports, pushing up prices for consumers to cover any potential losses.
What causes UK inflation to fall?
While rising inflation is a concern, it is possible to keep it under control. Understanding the factors that cause UK inflation to fall can provide insights into how it might develop in the future.
Declining demand
When consumers and businesses cut back on spending—often during periods of economic uncertainty or high-interest rates—demand for goods and services decreases.
This typically sees prices stabilise or fall.
Stronger currency
On the contrary to what we discussed earlier, a stronger pound reduces the cost of imports, helping to counteract inflation.
Global and domestic factors can play a role in determining the pound’s strength. The UK government can help boost the pound with effective and stable economic policies and trade agreements.
Also, the BoE’s monetary policies can increase the pound’s value by increasing interest rates. Read our article to learn more about how the BoE’s monetary policy affects the pound’s value here.
What could drive UK inflation in 2025 and beyond?
Looking ahead, several trends and factors could influence inflation in the UK:
Geopolitical tensions
Ongoing global events, such as conflicts or trade wars, could disrupt supply chains and energy markets, leading to inflationary pressure.
The UK’s reliance on global trade makes it particularly vulnerable to such shocks.
Green energy transition
As the UK transitions to renewable energy, initial investment costs could drive up inflation in the short term.
However, over the long term, reduced reliance on imported fossil fuels may stabilise energy costs.
Technological advancements
Technological innovation often leads to cost savings and increased efficiency. Automation in manufacturing and logistics could help keep inflation in check by reducing production costs.
Climate change
Extreme weather events can disrupt agriculture, leading to volatile food and drink prices. The UK has seen this in various ways, such as the increase in price of everyday items like coffee.
Climate-related disruptions may become a more persistent factor in driving inflation in the coming years.
Read our article on how climate change is affecting the price of coffee in the UK to learn more.
Fiscal policies
Government spending decisions, such as investment in infrastructure or public services, can stimulate demand and influence inflation. Conversely, austerity measures could dampen inflation by reducing spending.
In 2024, Sir Keir Starmer’s Labour government announced its first Budget with a mixture of cuts and increased spending. If one side proves to outweigh the other, we could see the government’s fiscal policies contribute to higher or lower inflation in 2025 and beyond.
What does rising inflation mean for you?
Inflation affects everyone differently:
- For consumers, it can lead to higher prices for essentials like food, energy, and housing.
- For businesses, rising costs can squeeze your profit margins, particularly if you can’t pass on price increases to customers.
It’s important to adopt financial strategies to manage the impact of inflation.
For individuals, this might include budgeting carefully or considering investing in assets, depending on your risk appetite, like gold, property, or commodities.
For businesses, hedging against currency volatility with strategies containing foreign exchange products like spot trades, forward contracts, and market orders can help limit risks and protect profits.
Conclusion
The rise in inflation in the UK over the last two months is a reminder of the various global and domestic factors impacting the economy.
While inflation presents challenges, understanding its drivers and potential future trends can help businesses and individuals prepare effectively.
Whether you’re a consumer or a business leader, strategising against inflation is crucial to protect your pockets and profits.
As discussed in this article, inflation can have a significant effect on the value of the pound–and vice versa. With the direction of the UK’s inflation uncertain, businesses should act accordingly to mitigate any potential damages.
For UK businesses making payments in foreign currencies, its crucial to consider using currency risk management strategies to limit the risk of exchange rate swings from impacting your bottom line.
At Privalgo, we specialise in helping businesses create personalised risk management strategies to do just that. We use a variety of foreign exchange products like forward contracts, market orders and spot trades to help you achieve your financial objectives.
Contact us to speak to a Privalgo Currency Specialist and find out more about how we can help your business grow in times of uncertainty.
10 FAQs on Inflation in the UK
Below are 10 frequently asked questions about inflation in the UK, including what causes it to rise and fall. Some of the answers feature content used in this article.
Why is inflation rising in the UK right now?
Inflation in the UK is currently rising potentially due to a combination of factors including rising energy costs, supply chain disruptions, labour shortages, and increasing wages. Geopolitical tensions and the depreciation of the pound have also added to the inflationary pressures.
What is driving up inflation in the UK?
Key drivers of inflation in the UK include:
- Rising global energy prices, which increase costs for transportation, heating, and manufacturing.
- Post-pandemic supply chain inefficiencies and Brexit-related adjustments.
- Wage growth as businesses compete for talent, particularly in industries facing labour shortages.
- Depreciation of the pound, making imports more expensive.
What makes up the inflation rate in the UK?
The inflation rate in the UK is calculated using indices like the Consumer Prices Index (CPI) and the Retail Prices Index (RPI). These indices measure the average change in prices of a basket of goods and services over time.
Why do we have a 2% inflation target?
The Bank of England sets a 2% inflation target to maintain price stability while encouraging economic growth. This level is considered optimal as it avoids deflation while ensuring prices rise at a predictable and manageable rate.
Is inflation a problem in the UK?
Inflation becomes problematic when it rises too quickly, as it reduces purchasing power, erodes savings, and increases costs for businesses. Moderately low and predictable inflation is generally healthy, as it encourages spending and investment.
How does the depreciation of the pound contribute to inflation?
A weaker pound increases the cost of imports, as businesses and consumers must pay more for foreign goods. This added cost is often passed on to consumers, contributing to higher inflation.
What role does monetary policy play in managing inflation?
The Bank of England uses monetary policy to manage inflation by adjusting interest rates. Higher interest rates make borrowing more expensive and savings more attractive, which reduces spending and helps to lower inflation.
How do supply chain disruptions impact inflation?
Supply chain disruptions, caused by factors like labour shortages and customs delays, increase the cost of transporting and producing goods. These costs are often passed on to consumers, driving up inflation.
Can inflation fall in the UK, and what would cause it to decline?
Inflation can fall due to declining demand, a stronger pound reducing import costs, or effective monetary and fiscal policies. Economic stability and improved global supply chains can also help lower inflation.
What can individuals and businesses do to manage the impact of inflation?
- Individuals: Budget carefully and consider investing in inflation-resistant assets like gold or property.
- Businesses: Hedge against currency volatility with tools like forward contracts, market orders, or spot trades to protect profits from exchange rate fluctuations.
Disclaimer: This article is for informational purposes only and does not constitute financial advice.
