What does a drop in inflation really mean?

The real-world impact of the latest news on inflation.

UK inflation figures have dropped surprisingly, down to  7.9% for June, far lower than the 8.2% anticipated by market commentators. In May, the figure had been 8.7%, the same as in April’s, triggering a Bank of England base rate rise to 5%, a figure not seen since April 2008.

The larger-than-expected drop was mainly caused by the cost of fuel falling, and food price rises slowing.

But what does the surprise drop in inflation mean for you? And how is it likely to affect interest rates, and what many pay on mortgages or earn from savings?

Credit: Shutterstock/ADragon

For those with a mortgage, the surprise drop in inflation may mean they won’t see such a huge jump in monthly repayments – whether on a tracker-rate mortgage that goes up and down in line with the Bank of England base rate, or have a fixed-rate one set to expire in the next two years or so.

Inflation is a key metric the Bank of England uses to determine its base rate. It has been far higher than the target of 2%, so monetary policy decision makers have been implementing an aggressive rate-hiking cycle to get it under control. 

Raising the base rate acts as a brake on the economy. When the rate increases, borrowing becomes more costly (and saving more rewarding). As a result, inflation can be tamed because people can’t afford higher prices.

Already, many people are struggling with unaffordable repayments, but if rates had continued to rise, repayments would have become too expensive for even more. The average rate for a two-year, fixed-rate mortgage has jumped from 2.34% in December 2021 to 6.8% this July.

What about the housing market?

This hike in mortgage rates has a knock-on effect for the rest of the housing market. When rates are lower, people can afford to borrow more, which can prevent house prices tumbling.

For those with a lot of your equity for retirement tied up in a home, a stable housing market is crucial to ensure your property (and equity) doesn’t lose value. 

So, with a more favourable economic backdrop, thanks to inflation falling, the Bank of England rate will likely not need to rise much higher than it is now. As a result, borrowing is less likely to become more expensive, so people can take out larger mortgages, creating a more stable house price market. 

Finally, as inflation comes down, the cost of living goes up at a slower pace. The purchasing power of your retirement fund doesn’t diminish as quickly therefore.

The downside

Clearly, it’s good news that the prices of goods and services are no longer rising at such a fast pace. However, ultimately, they’re still rising. So while price rises may not be going up by as much, or as quickly, there’s no denying that household budgets have been squeezed in the last 18 months. For those no longer earning a salary, that is undoubtedly a worry if you’re on a fixed monthly sum. 

The other problem with the level of inflation at the moment, falling or not, is that it is higher than the return on savings accounts.

At the time of writing in July, the best easy-access savings account interest rate is 4.65% according to moneyfactscompare.co.uk, which updates rates daily.

Inflation has also been so high, for so long, that returns seen on investments will have been eaten into as well, as interest fails to match the spiralling cost of living. Ultimately that means those with cash squirrelled away for retirement will have seen a further loss of purchasing power.

Finally, while inflation is lower, it is still four times higher than the Bank of England wants. The UK, especially compared to other G7 countries, is still seeing prices rise too quickly. It means that the prospect of rate cuts is still a way off. Sadly, there is a long way for inflation to fall before the Bank of England even considers a rate decrease. 

What you can do

Despite the negatives, the inflation surprise is good news as it means the economy should at least be heading in the right direction. Many economists expect inflation to fall quickly now. Suren Thiru, economics director at ICAEW, said that “June’s decline in inflation should be followed by a [further] hefty fall in July”. 

However, it could be that the good news has come too late for you, so your retirement has already been impacted. Perhaps the date you stop working has been pushed back, or the amount you have saved may not be enough for the life you want to lead. 

If that’s the case, or you are at all worried, it’s a good idea to seek the help of a financial adviser. They’ll consider all aspects of your situation and give you the information needed to make an informed decision about your options, and can help explain the best way to get the most out of your financial plans. 

Content in this article is for information and guidance only and is not intended as financial advice. It is not a substitute for professional financial services. 


Rachel Lee

Written by Rachel Lee


Having worked at Morgan Stanley and BNYMellon for over 10 years in pensions and investments, Rachel naturally started to move towards investment writing more and more in her day job. She now works as a full time business and financial writer – drawing from her hands on experience in the field to provide insight and analysis for Saga Exceptional readers.

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