The financial world can seem overwhelming at first but in a world filled with financial information, for those starting out there are only a few things that one should know before delving in deeper into other areas.

The two main, and most important concepts to understand are Interest Rates and Inflation. What are they? Why should I care about them?

Interest

Interest is the amount paid to an individual, person or company, for lending their money to someone else.

Example:

You borrow £1,000 from a bank to put towards your new car. This loan lasts for 12 months and has representative APR of 14.9%.
Therefore, the £1,000 loan over 12 months at 14.9% APR would mean an additional £77.24 paid over the year in interest.

This works the other way for you as well! When you have money in a bank account which pays interest, most standard current account do not, then you are receiving a sort of ‘reward’ form the bank for depositing money into their institution, which is then loaned out by the bank.

Interest Rates

Interest Rates are the rates central banks set creating the ‘wholesale’ price of money in the economy and at the time of writing this the interest rate in the United Kingdom is at 3.75%. However, banks add their own markup to this percentage. Which is exactly why some savings accounts are better than others, as the institutions compete for you to deposit your money with them.

Inflation

Inflation is the increase in price of good and services over time.

Example:

Inflation is wanted in society, the Bank of England targets around 2% inflation for the UK. So why is that? Imagine this, you are thinking of buying a phone and that phone costs £100, you think for days is this the right one or not, but then you remember that this time next year, the phone will cost £102, due to inflation.

However, there are situations when inflation get too high. A UK example of this is during COVID, where inflation reached 9.6% in October 2022, a figure which led to the Bank of England intervening by increasing interest rates, which cools down spending, brining prices back under control.

Why should I care?

You should care about interest rates, as it is one of the foundation blocks of a ‘developed’ economy, higher interest rates mean higher interest is needed to service debt, whether that be from a mortgage or government borrowing all is tied to the interest rate.

You should care about inflation as it is the amount by which prices increase, and therefore decreases the purchasing power of that money.