Prices surged by 5.4pc in the year to December as UK inflation hit its highest level in 30 years. Experts have predicted the cost of living crisis will deteriorate even further in the coming months. 

The Consumer Prices Index recorded its biggest increase since 1992 on the back of rising food, clothing and restaurant costs. This is well above the Bank of England’s 2pc target, and higher than analysts had predicted.

To combat soaring inflation, the central bank raised interest rates from 0.1pc to 0.25pc in December. However, the rate rise will likely not be enough to bring down prices and a series of further increases are widely anticipated this year. 

How much of a risk is rising inflation, and how can you protect your finances? Telegraph Money has the answers.

What is the cost of living crisis and how does it affect me?

Inflation measures the rate of increase in the price of goods and services. The Consumer Prices Index, which forms the basis for the Government’s inflation target, looks at the cost of hundreds of items, from food to cinema tickets, to track any rise or fall in costs.

Inflation has already risen to 5.4pc and is expected to rise again in the foreseeable future, more than double the official 2pc target. The ONS data shows the monthly increase was driven by food and non-alcoholic drinks, as well as restaurants and hotels, furniture and household, goods and clothing and footwear.

Governor Andrew Bailey has previously insisted the factors pushing up inflation should be temporary, but that depends on whether they feed into wage growth and prompt further price rises.

If inflation rises what happens to interest rates?

Inflation is bad news for savers and those on fixed incomes, who see their purchasing power reduce in real terms. 

That is because everyday expenses, such as food and fuel, are rising. Food prices are rising at their highest rate since August last year, according to data firm Kantar. 

However, those with debts on fixed repayment plans can benefit from inflation, including the Government, as the size of the amount owed is reduced in real terms. 

Will inflation harm my investments?

Bond owners could suffer the most. Investors sell bonds – which pay a fixed return, or “coupon” – when inflation rises as it eats into the real value of that income. Higher inflation would also increase the likelihood the Bank of England raises interest rates, which would be bad news for bonds as it decreases the relative value of their payments versus newly-issued bonds. 

Famed investor Warren Buffett has always warned investors off buying bonds when inflation rises. He said they were “not the place to be” and investors faced a “bleak future” because the income they offered was at rock bottom. Rising inflation would decrease the real value of this income further. 

Investors can protect themselves by buying index-linked bonds, where interest paid rises in line with inflation. 

Inflation, in moderation, is not necessarily bad for stocks, as companies can pass costs onto consumers to balance out rising input costs. Companies which have strong pricing power, such as utilities or large consumer brands, should be able to carry on with business as normal. 

Richard Hunter, of stockbroker Interactive Investor, said oil and mining companies would do well as rising commodity prices would be good for their bottom lines. He added that utility groups often pay dividends linked to inflation. “Investors benefit from a double whammy of passing costs onto consumers and bigger dividends,” he said.

However, inflation could be bad for retailers, such as supermarkets, which may lack the ability to increase prices, he said.  

Infrastructure and real estate investments often have contracts linked to inflation, so their income and dividends would rise as inflation does. Gold could also rise in value. Supply is relatively fixed, so more money floating around the economy should increase what people are willing to pay.