Explainers / Economy
What is inflation?
Why 3% inflation turns a £10 lunch into £13.44 in ten years, and what that means for your savings.
By Kinza Updated 29 September 2026 2 min read
It compounds
3% inflation means prices are, on average, 3% higher than a year ago. The trap is thinking that ten years of 3% adds up to 30%. It doesn’t, because each year’s rise is applied to prices that have already risen.
| After | A £10 lunch costs |
|---|---|
| 1 year | £10.30 |
| 5 years | £11.59 |
| 10 years | £13.44 |
| 20 years | £18.06 |
Twenty years of “only 3%” and the price has nearly doubled.
The same maths, backwards
Now imagine £100 sitting in a drawer, or in an account paying no interest. Prices go up 3% a year and the note stays £100. After ten years it buys what £74 buys today. The number on the note has not changed. What it can do has.
This is why “just save it” is only half an answer. Money only keeps its buying power if the interest it earns at least matches inflation. Analysts call the difference between the interest you earn and inflation the real return. A 4% savings rate with 3% inflation is a real return of about 1%. A 2% rate is a real loss.
Why the target is 2% and not zero
The government sets the Bank of England a target of 2% inflation, measured by CPI, not 0%. The Bank explains why: if inflation gets too low or turns negative, people may put off spending because they expect prices to fall. Less spending can mean businesses fail and people lose their jobs. A small, steady rise in prices avoids that risk.
The analyst habit
Whenever you see a number from the past, ask what it would be today. The Bank of England’s calculator, linked below, does it for you. A £1 pocket money in 1990 and a £1 pocket money now are not the same pound.