Inflation vs Wage Increase

Inflation

Inflation reached 3%, versus the Bank of England's target of 2%. 

What does this mean? The below blog sets to unpick this.

How we measure inflation

Inflation is the price increase in products. The speed at which this happens at is known as the inflation rate. 

Inflation is measured in a number of ways:

  • Consumer Price Index (CPI): this is the cost of a "basket of goods"; it covers over 700 household goods such as clothes, food, transport, and the price of them. The "basket" is weighted dependent on goods that we spend more on. The movement is know as the price index. The CPI also covers switching costs which involves people choosing cheaper products, such as basic white bread, rather than Sourdough...
  • Retail Price Index (RPI): similar to the CPI, this is the cost of a "basket of goods". However, the RPI also covers household costs such as council tax, rent and mortgage payments. The RPI is also calculated differently to the CPI; RPI is based on an arithmetical calculation, compared to the CPI which is geometrical. Investopedia does a fantastic job of explaining these mathematical differences; based on the maths RPI tends to come our higher in the calculations of inflation, whereas, I would argue the CPI is more accurate, based on a weighting of returns and investments. 

 

How does this apply?

The CPI is the most typically used measure of inflation.

Inflation in the UK reached 3%; the main reason for the increase relates to food and transport costs. This is the highest its been since 2012.

Inflation is driven by a number of factors which I outlined in blog 10; these factors include interest rates, exchange rates, political factors (Brexit played a large part in driving up inflation). 

 

What's the Problem?

Increased inflation means that the cost of goods increases; we have to pay more for household products, transport, petrol, electronics etc. Inflation and interest rates are interlinked; the pressure of inflation is causing the Bank of England to address the interest rates which are at an all time low. Interest rates will go up shortly. Increasing interest rates means that individuals who have significant amounts of borrowing (car loans, mortgages, hire purchase anything) will have to pay additional interest back on top of increasing prices of goods. Everything is more expensive. 

This is fine...as long as wages are also increasing. This would mean you are being paid more money to cover the increased costs of products. 

Unfortunately, wages only rose at an annual rate of 2.1% in the three months to July 2017. 

The cost of living is outweighing how much is being earned; this puts financial strain on more people. Borrowing money no longer becomes an option as interest rates rise, placing pressure on repayment schedules. 

 

What Can I Do?

A number of things:

  • Pay off debt; if you have debt linked to a floating rate of interest, reduce it as quickly as you can otherwise your monthly instalments will increase in line with increasing interest rates. 
  • Reduce your spending: according to the Money Advice Service, 1 in 3 people put their spending on credit cards. Try to live within your means, and where possible reduce spending. In my opinion, cash is king. Having cash means you have options. 
  • Haggle for a payrise: benchmark your wages in line with other people. Are you on the right salary for your role, and the number of years experience? If not, ask for a pay rise to be in line with industry standards. Websites such as Glassdoor, provide great benchmarking options. 

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Wee Scot Finance