What is “sticky inflation” and how can it affect your finances?

A woman holding groceries and looking shocked at the bill.

Although the cost of living crisis is no longer dominating the news, you may still be feeling the pinch from the high inflation levels of recent years.

After reaching more than 11% in 2022, inflation finally returned to the Bank of England’s (BoE) target rate of 2% in May 2024.

However, it still exceeded the target rate for nine months last year, and data from the Office for National Statistics (ONS), shows that inflation stood at 2.5% in December.

This situation, where inflation remains persistently above the target rate, even if only by a small margin, is known as “sticky inflation”.

Read on to discover how sticky inflation could affect your finances.

Sticky inflation could mean the Bank of England maintains higher interest rates

To help combat spiralling inflation, the BoE incrementally raised the base rate from 0.1% in December 2021 to a peak of 5.25% by August 2023. It then held the rate at that level for a full year before beginning to lower it in the summer of 2024.

However, in response to a renewed uptick in inflation, the BoE opted to pause further cuts in its December meeting and held the base rate at 4.75%.

Although the BoE may gradually decrease the base rate in the coming months, any reductions are likely to be slow as it works to keep inflation in check. This could have a significant effect on your finances, especially when it comes to saving and borrowing.

While inflation typically erodes the value of your cash savings, higher interest can provide an opportunity for your savings to grow at a more competitive rate. Indeed, the current base rate is 2.25% higher than the latest inflation reading.

However, higher interest rates generally also mean an increase in borrowing costs. This may particularly affect you if you have a variable-rate loan or mortgage, or are approaching the end of your fixed-rate term.

Sticky inflation can increase your expenses and erode the real-term value of your cash

It’s important to remember that “lower” inflation rates don’t mean prices are falling, only that they are rising more slowly.

During the cost of living crisis, you likely noticed the effects of inflation as prices rose quickly. Although the rate of increase may not be as dramatic now, prices have not returned to their pre-crisis levels and continue to rise at a higher-than-optimal pace due to sticky inflation.

Persistently high inflation can significantly affect your day-to-day expenses, and it can erode your purchasing power if your wages don’t keep up with the rising costs.

Your cash savings are also vulnerable to inflation – even when it is at stable levels – as the returns offered by many savings accounts often lag behind the inflation rate.

Although the base rate may be higher than inflation at the moment, this is not the norm. The graph below shows the UK inflation rate alongside the BoE base rate between January 2018 and October 2024.

Source: Statista

As you can see, inflation was consistently the higher of the two until the end of 2023. This means it’s likely that throughout most of this period, your cash savings would have struggled to keep up with inflation.

So, sticky inflation can have the dual effect of pushing up prices and reducing the real-terms value of your cash, both of which can reduce your purchasing power over time.

There are a few steps you can take to protect your finances against sticky inflation

Although sticky inflation is typically detrimental to your finances, there are several strategies you can adopt to help mitigate its effects.

Adjust your budget

As prices continue to rise, adjusting your budget to align with your current income and regular expenses can help you stay on top of your outgoings.

By regularly reviewing your spending in relation to your income, you can work to ensure that sticky inflation doesn’t hinder your progress toward achieving your long-term financial goals.

Invest in the stock market

As you read earlier, cash savings can struggle to keep up with inflation. While it’s a good idea to keep some savings in cash for emergencies and luxury one-offs like holidays, investing a portion of your wealth in the market could help protect its purchasing power over the long term.

Research by Schroders shows that, over various time horizons, cash has roughly a 60% chance of outpacing inflation. However, the same analysis reveals that, over longer periods, the market offers a much higher chance of beating inflation, reaching a 100% success rate over a 20-year horizon.

So, although the market can experience short-term fluctuations, long-term investments have the potential to generate returns that outpace average inflation, helping to protect your wealth for the future.

Diversify your portfolio

If your daily expenses increase due to inflation, having a diversified portfolio can help to offset the impact.

By spreading your investments across different asset classes, you can balance rising prices with gains in other areas.

For example, if you own a mortgage-free second property or a luxury item like a sports car, the appreciation in your asset’s value could help you build wealth in line with inflation.

Get in touch

A financial planner can work with you to help protect your finances against the effects of sticky inflation and ensure you remain on track to achieve your long-term goals.

To speak to a financial planner, get in touch.

Email info@blueskyifas.co.uk or call us on 01189 876655.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.