You get called into a meeting, and your manager tells you you’re getting a 3% pay rise. For about ten seconds it feels great. Then a few months go by and, somehow, you don’t feel any richer at all. The bigger number lands in your account every month, but the shopping still costs what it costs, the bills still turn up, and you feel a little more stretched than before. So what happened to the rise?
The pay rise that vanished0:00
The rise was real. Your payslip says so: the number went up. What ate it was inflation, the steady rise in prices across almost everything you buy.
Here is what that can look like in a single household. Before the rise, £2,000 comes in each month, £1,900 goes out, and £100 is left over. After a 3% rise, £2,060 comes in. But prices have climbed too, so the same spending now costs £1,967, and only £93 is left. More money in, less left over.
| Before the rise | After the rise | |
|---|---|---|
| Money in | £2,000 | £2,060 |
| Money out | £1,900 | £1,967 |
| Left over | £100 | £93 ↓ |
Once you see how that happens, you’ll never look at a pay rise, or a price tag, the same way again.
Nominal vs real pay0:53
How can more money leave you no better off? It comes down to two numbers.
The first is the number on your payslip. Economists call it your nominal pay. The second is what that number can actually buy when you go out and spend it. That’s your real pay. Inflation is what turns one into the other.
Picture a weekly grocery shop that costs £50 this year: bread, milk, the usual things. Next year prices rise, and the exact same basket costs £51.50. Nothing about the shopping has changed. Only the price tags have moved.
If your pay also went up by 3% over that year, you can still buy the same basket. Your payslip says you earn more, but your real pay hasn’t really moved.
Now the part that stings. If prices went up by 5% and your pay rose by only 3%, you’re not standing still. You’re going backwards. You can buy less than you could a year ago, even though more money lands in your account every month.
Your own inflation rate2:10
Even that comparison can mislead, because the inflation figure on the news isn’t your inflation rate. It’s an average. Imagine one enormous shopping basket holding a bit of everything households across the country spend money on: food, rent, petrol, phone bills, haircuts, holidays. All of it is mixed together and boiled down into one number.
Nobody actually buys that basket. You buy your own things, and your prices may be rising much faster than the average, or much more slowly.
Take two people, Amy and Tom. They earn the same salary, and both get the same 3% pay rise.
Amy
Rents her flat and drives to work.
- Rent: up nearly 4% ↑
- Petrol: up about a fifth ↑
Her biggest bills are rising faster than her pay.
Tom
Owns his home outright and gets the train.
- Rail fares: down a little ↓
- Food: up just over 1% ↑
His biggest bills are rising more slowly than his pay.
So Amy feels poorer and Tom feels fine, and they’re both right.
That’s the point. If the things you spend most on have been climbing faster than the average, your own inflation rate is higher than the one being reported, and your pay rise had even more ground to make up than you thought. You can work out a rough figure for yourself with the calculator on this page, which puts your own rate straight next to your pay rise. The Office for National Statistics also has a free personal inflation calculator on its website.
Which inflation number to use4:16
There are really two questions you might be asking, and they need two different numbers.
Did I end up better or worse off over the last year? For that you look backwards. Take how much your pay rose over the year and put it next to how much prices rose over the same year. That’s exactly how the official figures work. Say average pay goes up about 3.5%. Once you take off what prices did, real pay might rise by a bit less than 1%. People get a little better off, just nowhere near as much as the headline pay figure suggests.
What will this rise be worth over the year ahead? That’s harder, because now it’s future inflation that matters and nobody knows exactly what it will be. So you use two things: the latest published figure, which tells you what prices have been doing recently, and forecasts, which give a best guess at what comes next. Say the Bank of England’s forecast has inflation edging up to around 3.2%, then easing slowly. On that forecast, a 3% rise would roughly keep pace, but not much more. Neither number is perfect, but together they give you a good sense of direction.
Whichever question you’re asking, the rule is the same: compare like with like. Your pay rise covers a year, so set it against prices over that same year, not last month’s figure and not a number you half remember from the news.
That’s all anyone really means by “my pay rise didn’t keep up with inflation”. The rise was real; prices just climbed faster. Most people never check which of the two was bigger. They see the payslip go up and take it as proof they’re doing better.
Who inflation hurts most6:43
Inflation doesn’t affect everyone the same way. Whether it hurts you, or occasionally helps you, depends on what your finances look like. It creates winners and losers, and it’s worth knowing which side of the line you’re on.
If your pay tends to rise roughly in line with prices, through regular reviews, negotiation or simply working in a field where pay is climbing, you’re better protected. Your real pay doesn’t shift much, because the increases roughly keep up.
If your pay is fixed, or it’s reviewed once a year and barely moves, or you’ve stopped working and live on an income that doesn’t rise with prices, inflation eats away at what you have, month after month. There’s no single dramatic loss you can point to on a statement. It’s a slow leak: a little more of your money going on the same things every month, until one day you wonder where it all went.
And here’s the counterintuitive one. Debt can work the other way round.
Debt: fixed vs variable rates7:40
This is the part people find hardest to believe, so let’s use numbers.
You borrow £10,000 on a fixed rate and repay £500 a month. Over three years, prices rise and your pay drifts up with them: not beating inflation, just roughly keeping pace.
The £10,000 you owe hasn’t changed. Nor has the £500 a month. But your pay has, so that same £500 is now a smaller slice of what you earn than it was three years ago. The debt didn’t shrink; your ability to carry it grew. That one part of your finances quietly moved in your favour.
The part that usually gets left out is that this only works if your rate is fixed.
On a variable rate, things can go the other way. When inflation stays too high for too long, central banks may raise interest rates to bring it back under control. Variable borrowing rates tend to move with them, so your monthly repayment can rise too. That £500 becomes £550, maybe £600, and it can stay higher for as long as borrowing rates stay high.
Variable rates and your savings8:51
So, the honest version. On a fixed rate, with pay creeping up alongside prices, your £500 quietly becomes a smaller slice of your month. Nothing changed; you simply grew around it. On a variable rate, your loan payments go up as well, right alongside all your other costs. The fixed borrower gets a break. The variable borrower doesn’t.
Savings follow almost the same rule.
| Savings at the start | £5,000 |
|---|---|
| After a year at 2% interest | £5,100 |
| Needed to keep up with prices rising 3% | £5,150 |
| Behind in real terms | £50 ↓ |
£5,100 feels like progress. But with prices up 3% over the same year, your £5,000 needed to become £5,150 just to stand still. You’re £50 behind, and your balance never once went down. That’s the whole trick.
What it means for you9:51
Not the textbook version. Yours.
Your pay rise. Don’t just look at the percentage in the letter. Put it next to what prices did, or are expected to do, over the period the rise covers. If your pay goes up 3% while prices go up 4%, you’ve taken a real pay cut. It doesn’t feel like one, because the number on the page still went up.
Your savings. Find out what your account actually pays, and compare that rate with inflation. That’s the number that matters.
A fixed retirement income. Some retirement income rises with prices, and that gives some protection. But if someone in your life lives on an income that stays flat while prices don’t, inflation hits them particularly hard. Unlike a salary, there’s no pay review coming. Nobody is going to raise that income to match prices. It stays exactly where it is while everything it buys gets dearer.
Investing. This is the flip side. Over long periods, investing gives your money the potential to grow faster than prices, but there’s no guarantee, and the price of that higher potential return is investment risk: your money can go down as well as up. Cash doesn’t carry the same investment risk, but over long periods it generally offers much less growth. That’s the trade you’re making, and we’ll look at how it works in a later episode.
Investing: the reality check11:28
Investing is the part that gets oversold, so here is the reality check. Investing comes out of your surplus, the money left once the bills are paid. If inflation is eating your income, it’s shrinking that surplus at the same time, so there’s less to invest in the first place. That’s the real problem, and investing £30 a month doesn’t touch it. Protect the income, and the surplus looks after itself.
The same rule does apply to money you’ve already invested. If your returns don’t beat inflation, that money is going backwards in real terms, just like cash in a savings account. So yes, you want returns ahead of prices. But that protects what you already have. It isn’t a way out of an income that keeps losing to prices, and anyone telling you otherwise is selling something.
None of this means panic. It means knowing which side of the line you’re on, for each part of your finances. Some parts are protected from inflation; others aren’t.
The one rule to remember12:37
If you remember one thing, make it this. Never judge a pay rise, a savings return, or really any number involving money, on its own. Always put it next to what prices did, or are expected to do, over the same period.
Real gain
Pay up 3%, prices up 1%.
Real loss
Pay up 3%, prices up 6%.
Same pay rise. Completely different outcome.
That one distinction, nominal against real, is one of the most useful ideas in personal finance. Once you start applying it, you’ll see it everywhere: in your salary, in your savings account, in the rate on your mortgage. The same trick, playing out over and over.
Next time, we look at why the Bank of England raises interest rates when prices rise, and what that does to your budget, your savings and even your job.