Inflation: Who is hardest hit?

Inflation is one of the key economic measures

Inflation - or the rising cost of goods and services - is one of the key measures that affect our financial well-being.

And it is now undermining the living standards of most people in the UK.

Although the rate of inflation has generally dropped over the last year, prices are still rising above the government's target rate of 2%.

The inflation rate still stands higher than the level of wage rises, so millions of people are seeing their household bills rising - and their income failing to keep pace.

What is inflation?

Inflation is the rate of change in the level of prices for goods and services, which affects the purchasing power of money.

It is measured by the Office for National Statistics, which charts the prices of hundreds of goods and services - from basic items such as bread to new products.

On the government's preferred measure of inflation, the Consumer Prices Index (CPI), inflation stood at an annual rate of 2.5% in August, compared with 2.6% in July.

But as with many economic measures, the headline figures do not always tell us the whole story.

So, with prices rising, who is being hit the hardest?

Interest and savings

The key is to consider inflation alongside wages and interest rates.

At present, interest rates are at a record low. With the Bank of England's main rate, Bank rate, at 0.5%, savings are not gaining in value very much.

This particularly hits those who have not moved their savings around to get a better rate of interest.

The Bank of England says that the average instant access account offers interest of just 0.21%, while cash Individual Savings Accounts (Isas) offer, on average, just 0.66%.

Following the August inflation figures, financial information service Moneyfacts said that a basic rate taxpayer needed to find a savings account paying 3.12% a year to beat CPI inflation.

A higher rate taxpayer, with an income tax rate of 40%, needed to find an account paying at least 4.2% to beat CPI inflation.

Taxpayers could choose from 198 accounts that negated the effects of tax and inflation out of a total of 1,017 on the market, Moneyfacts said.

"Once again, we have the ridiculous situation where we have more savings accounts that do not beat inflation than those that do," said Sylvia Waycot at Moneyfacts.

"Savers need to be vigilant and take advantage of tax breaks such as Isas and, if they can, lock their money away for a fixed period to ensure better rates."

Pensioners

Anyone on a fixed income or trying to live off the income from savings is suffering from the effects of inflation - because the things they are buying are rising in price, unlike the funds they have to pay for them.

People on low incomes have suffered higher inflation than those on higher incomes in the past decade, according to a study by the Institute for Fiscal Studies (IFS).

The IFS said the difference in fortunes had been particularly marked since 2008, with pensioners on state benefits especially hard hit.

People on lower incomes spend a higher proportion of their money on gas, electricity and food, while those on higher incomes have benefited more from lower mortgage rates.

Investment company Alliance Trust suggested that in August, all age groups witnessed a lower inflation rate than in July.

However, for the 10th consecutive month, the over-75 age group still had the highest rate of inflation, at 2.8%.

This was primarily the result of the higher proportion of their income that this group spends on domestic gas and electricity, as well as food which has seen a pick-up in prices.

Workers who have seen their wages held down, or even frozen, are seeing their spending power fall.

However, 30 to 64-year-olds witnessed the lowest inflation rate in June, the Alliance Trust said, at 2.3%. The 30 to 49-year-old age group has seen the lowest level of inflation since the start of the year. The latest dip in their inflation rate was a result, in part, of lower clothing and footwear prices.

Inflation is also used in the calculation of some services, such as rail fares.

A formula links some regulated rail fares - such as season tickets and off-peak intercity tickets - to the Retail Prices Index (RPI) measure of inflation in July.

From January, rail fares in England will rise by 6.2%, while in Scotland they will go up by 4.2%. Wales has yet to set a figure for its increase.

There are no fare increases currently planned in Northern Ireland, where fares are not linked to RPI, after a 3% rise in April.

The September measure of inflation will instruct the increase in a number of benefits next April.

Is anyone winning?

While inflation and low interest rates may be eating away at savings, the same effect could be good news for those in debt.

Over time, the value of the debt will reduce, since the amount borrowed will not be worth as much, because of the effects of inflation.

In fact, 4% inflation every year will halve the value of money in 18 years. Inflation at 5% will do the same in just 14 years.