What are Inflation, Recession, and Interest Rates?

You may feel as if terms like ‘inflation’, ‘recession’ and ‘interest rates’ have been saturated in the UK media. This is due to the fluctuating state of the UK economy due to various factors such as recovery from the COVID-19 pandemic, the Russia-Ukraine war and other international affairs. However, what do these terms mean?

Our blog will take you through these key terms contextualising them for you and your business. 

Inflation 

In the simplest terms, Inflation is an increase in the price of goods and services over time. 

In the UK the rate of inflation is measured by the Office of National Statistics (ONS) when they track the price of a basket of goods. The ‘basket’ is regularly updated to reflect shopping trends, this is in order to provide an accurate picture of inflation. 

The biggest effect of inflation, felt by everyday people, is the loss of buying power. For example, you may have noticed that £50 no longer covers your groceries for the month, whereas, two years ago £50 may have brought you enough groceries and more. This is the loss of your buying power due to inflation. 

Another effect of inflation is the risk of your savings losing value. Essentially as your buying power decreases, your savings may buy less.

At the time of writing (October 2023) certain goods have fallen in price but inflation remains at a high, 6.7% to be exact, due to this we have limited buying power and consumers may spend more thoughtfully or choose to save instead of spend. 

Interest rates 

Interest rates are the amount a lender will charge you to borrow money, it’s based on a percentage of what you borrow. However, you can also earn money from interest rates through savings. Essentially, an interest rate tells you how much it costs to borrow or how much it rewards you to save. 

When interest rates are high it costs you more to borrow money for things such as a business loan or a mortgage. However, it may make you more money when you save in a high-interest savings account. 

The key interest rate in the UK is the ‘bank rate’ set by the Bank of England. This bank rate influences other interest rates in the economy, such as interest rates charged by high-street banks. 

There are also differing interest rates due to the time given to borrow or save. For example, your credit card may have an incredibly high rate of borrowing as that is money you loan and pay back monthly. However, your interest rate on your mortgage will be a lot lower as you pay it back over a longer period. High-street banks also use other factors alongside the bank rate to determine interest rates. Such as the risk of the loan not being paid back, the higher the risk, the higher the rate. 

Interest rates are determined by a number of factors, most notably interest rates rise with inflation. This is, theoretically, to curtail people from spending and borrowing, and encourage saving. Things such as an unstable economy can trigger higher interest rates and more people saving than spending can cause the economy to shrink. However, it also allows people to build a reserve of funds, which are hopefully expanding with the high-interest rate on savings. 

Recession 

A recession is when there is a prolonged period of economic downturn or a shrinking economy. Recession is incredibly complex to determine, however, in its simplest form a general way to understand recession is when the GDP falls for two three-month periods (quarters) we can assume that a country has entered a recession. GDP is the total value of the goods and services produced by a country. 

Recession does not have a sole cause, it can be down to a lot of factors, such as wars, debt, and over-extension of credit. Since the pandemic, Brexit, and constant changes in leadership, the UK’s economy has faced a number of challenges.

You may feel as if the media have constantly been yo-yo-ing from saying we are recession-bound to saying the economy is back on track. This is because recession can only be predicted, and small changes like the Bank of England holding the interest rate can cause ripple effects. Whilst this can be frustrating and worrying, the news cycle does allow businesses and people to prepare for the worst-case scenario. It is possible to recession-proof and adjust your business to run during times of economic uncertainty. 

Whilst all we can do is prepare for recession, it is good business practice to make a plan for harder economic times. You can rework your business plan to see how it may function when you have to be stringent with your budget. You can consider looking at the available grants to give your company a financial boost or strip back on unnecessary expenses such as rent and opt for the use of day offices or bookable meeting rooms.