The Bank of England has cut interest rates to the lowest level in two years. According to the Guardian, the bank’s decision to reduce interest rates from 4.25% to 4% on Thursday 7 August was driven by fears that rising food prices could push inflation up higher.
Official figures from the Office for National Statistics shows inflation stood at 3.6% in June 2025, up from 3.4% the month before. Yet experts are now concerned that spiralling food prices could mean inflation hits 4% by September.
If you have a mortgage it’s likely that bank’s decision to cut interest rates will be extremely welcome as you could see your monthly repayments drop in the future. That said, if you have savings, the news may not be quite so welcome as it could reduce your cash’s growth potential.
Worse still, high inflation could reduce the value of your cash in real terms over the long term. Before you read on to discover why, 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 less in the future than it does today.
To demonstrate this, the BoE’s inflation calculator reveals that you’d need to have £177.22 in June 2025 to have the same spending power as £100 in June 2005. In other words, your money had to grow by more than 77% over the last 20 years to keep pace with the rising cost of living.
If it didn’t, its value dropped in real terms.
Raising interest rates helps to tackle one of inflation’s biggest drivers
In the past, interest rates have been increased to bring inflation down. This is because higher interest rates tackle one of the biggest drivers of inflation: consumer demand.
Higher rates mean the cost of repayments for loans – and in particular mortgages – increases, which in turn reduces households’ disposable income. As a result, consumer demand drops. With this in mind, the BoE’s decision to drop interest rates in August 2025, while inflation remains high, is unusual. According to the BBC, the move was aimed at reducing unemployment and increasing job vacancies as fears about the UK economy continue.
Yet the decrease in interest rates while inflation remains high means the returns on cash savings may not keep pace with the rising cost of living. If this happens, your money could fall significantly in value 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. As such, investing your money could help to expose it to higher levels of growth potential, which in turn, could help to inflation-proof your hard-earned money.
Furthermore, it may mean you enjoy greater returns over the long-term, although you should always remember that past performance is no guarantee of future performance.
To demonstrate the stock market’s performance against cash savings, you might want to consider the following graph. It shows 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 significantly higher returns than cash over the long term, despite downturns along the way. That said, always remember you could receive back less than your original investment.
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Monday 11 August 2025