As is often the case when a new political party takes office in Downing Street, the last few months have seen a flurry of policies announced. The opportunity is there for the government to make their mark with favourable policies. They can also make unpopular decisions whilst blaming the inherited state of the economy. These policies can have a knock-on effect on the economy as it reacts to the announcements.

Over the last month, the UK has seen a drop in the Bank of England base interest rate, 4.75%, and also a rise in inflation to 2.4%. With seemingly conflicting effects, you may be confused if this will have an impact on your pension and retirement planning. Here we’ll explore the impact of both interest rate and inflation on your pension.

What do we mean by interest rate and inflation?

An interest rate is the amount it costs to borrow money, or the return you’ll receive on saving money. So, if you borrow £100 on an interest rate of 4%, you must pay back £104. The Bank of England sets a base rate that will impact everyday life for many. The interest rate paid on mortgages is impacted by the bank rate, and conversely, the return you’ll see on pension fund investment will also be impacted.

Inflation is a measure of how much it costs to purchase items now as compared to a year ago. The rate of inflation shows how much more items cost now, on average, than a year ago. It is calculated each month by the Office for National Statistics based on the Consumer Price Index. This is where the cost of a selection of goods are compared to see how their prices change month-to-month – it’s the same items each month, for consistency.

Recent changes to the Bank of England base interest rate and inflation

When the Labour party won the General Election in July, the Base Rate was 5.25%. This was the highest it had been since early 2008, as part of the solution to tackling high inflation. The Base Rate dropped to 5% in August, and then further dropped to 4.75% in November. At the start of 2024, the UK inflation rate was 4% but this dropped to 2.2% by the change in government. It further fell to 1.7% in September, but was reported to have increased back up to 2.3% in October. This is the largest monthly jump in inflation for 2 years, and has risen back above the government target of 2%. Inflation is currently at its highest level in 6 months.

When inflation is high, the Bank of England seeks to reduce it by raising the Base Rate. This encourages people to save more, as they’ll receive a higher return. If more is saved, then less money is being spent and prices will fall in order to encourage spending. This, in turn, means that inflation will lower. In this way, inflation and the Base Rate are intrinsically linked.

Following the Government’s Autumn Budget at the end of October there is concern that inflation may rise further. This is due to business expenses increasing with the rise in both the National Living Wage and National Insurance contributions for employers. Higher business expenses could be passed on to consumers, which would raise inflation and ultimately, the Base Rate. Not enough time has passed yet since the Budget to know the ramifications of these policy announcements. But aside from an increased cost of living, what does higher inflation and Base Rates mean for your retirement planning?

What does high inflation mean for your pension?

The inflation level in the prior September is one of the factors used in the State Pension Triple Lock. This is the calculation used to determine the increase in State Pension each April. The highest of the following factors is used:

• Inflation
• Average increase in wages between May and July
• Flat rate of 2.5%

In April 2025, the State Pension will increase by 4.1%, due to the average increase in wages.

In regards to private pensions, inflation must be taken into consideration when calculating growth. Pension schemes are an investment, and the aim is for the pot to grow over time. There is no guarantee, however, that it will grow in real terms. Inflation reflects how much can be bought with the same amount of money. For example, if your investment grew at 4% over a given period and inflation was 4.5%, then your investment will actually have grown at an effective rate of -0.5%. Inflation is therefore still important to determining the growth of your pension pot even if it is not in cash.

How does the Base Rate impact your pension?

The Bank of England base interest rates do not directly impact your pension. However, interest rates can impact the stock market. This can therefore impact the stocks your pension funds are invested in. A better performing stock market can mean more growth for your pension, which means positive things for your retirement planning.

Should you worry about how your retirement will be impacted?

The inflation rate is updated on a monthly basis, and the Base Rate is assessed every 6 weeks. The Bank of England makes corrective action where required to mitigate the impact of inflation. Despite the decrease in Base Rate earlier this month, it is not expected that it will be decreased further in December. This is in the hope of mitigating the effect of the elevated inflation.

If you have any concerns about how changes to the inflation and Base Rate will impact your pension, please contact us. We’ll talk you through any potential impacts and any steps we can take to mitigate the impact.