In the wake of trade wars sparked by President Trump, the Bank of England (BoE) has cut its interest rate from 4.5% to 4.25%. The reduction was the fourth in the past year, and according to the BBC, the bank considered slashing the rate to 4% over concerns that the global trade war could hit UK economic growth.
Little wonder then, that the Beeb also reveals the bank’s Governor, Andrew Bailey, hinted that more cuts could follow in the coming months. If you have a mortgage, the news is likely to be extremely welcome as you could see your monthly repayments drop at some point in the future.
That said, if you have savings, the news may not be quite so welcome, as it could significantly reduce your cash’s growth potential. While this is bad enough, it may not be the whole story, as inflation may mean the value of your savings drop even further.
Read on to discover the reason for this, and why investing your cash might be something you want to consider as it may expose your money to greater potential growth. Before you do though, let’s take a closer look at how inflation works.
Inflation measures the rising cost of living over time
Inflation is the increasing price of goods and services, which has the potential to affect everything from your utility bills to your weekly shop. Over the long term, inflation devalues your money in real terms, as £100 is likely to buy you more today than it will in the future.
While low levels of inflation are seen as the sign of a healthy economy, if it starts to rise too high it can become damaging to the national economy.
One reason for this is that it can push up the price of raw materials, which then increases the cost of production and reduces the profits made by businesses. To demonstrate the effects of inflation on your wealth, you might want to consider the BoE’s inflation calculator. It reveals that you’d need to have £174 in March 2025 to have the same spending power as £100 in March 2005.
This means that your money would have had to grow by nearly 75% over the last 20 years just to keep pace with the rising cost of living. If it didn’t, its value will have dropped in real terms.
Raising interest rates help to tackle one of inflation’s biggest drivers
In the past, interest rates have been used to bring inflation down when it starts to rise, as doing so tackles one of the biggest drivers of inflation: consumer demand. A key reason for this is that higher rates mean the cost of repayments for loans – and in particular mortgages – increase, which in turn, reduces disposable income for millions of households.
In addition to this, higher interest rates encourage people to save rather than spend. As a result, people spend less and consumer demand drops. At the start of 2025, inflation jumped unexpectedly to 3%, however data from the Office for National Statistics reveals that it had fallen to 2.6% in March. While this is still higher than the BoE’s target inflation rate of 2%, concerns about the UK economy resulted in the bank reducing its interest rate to 2.25%.
When you consider that inflation remains above the BoE’s target and interest rates for savings may fall in the near future, there is a real risk that the value of cash savings could fall in real terms.
Investing your cash may expose it to greater growth potential
It’s not all bad news though, as historically the stock market has tended to outperform cash savings. To demonstrate this, you might want to consider the following graph, which tracks the performance of a medium risk investment portfolio between 1 January 2005 and 31 January 2025.
Data sourced from Morningstar by AFH Wealth Management. The 60:40 portfolio allocates 60% to MSCI All Country World Index (ACWI) and 40% to Bloomberg Global Aggregate.
As you can see, the investment portfolio provided significant higher returns than cash over the long term, despite downturns along the way. That said, always remember that past performance is no guarantee of future performance and you may receive back less than your original investment.
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16 May 2025