Sounds like the '70s: inflation is re-released

The pen top, thankfully, has stayed firmly on.

On Tuesday it emerged that inflation had crept down to 2.8 per cent last month. This takes it back under the 3 per cent ceiling which, when broken through, demands that the Bank of England Governor Mervyn King write a letter to the Chancellor of the Exchequer to account for the setback.

The good news that the cost of living is, for now, falling is down largely to a drop in energy bills.

In March, the consumer price index (CPI) hit 3.1 per cent - its highest level for 11 years - prompting Mr King's first letter of explanation to Gordon Brown, and giving rise to fears that the Bank would make punitive use of its most effective weapon to curb inflation: a rise in interest rates.

The prospect of higher borrowing costs for millions of homeowners on variable rate mortgages usually puts the squeeze on household budgets and erodes consumer confidence, with all the attendant economic ills.

But despite the panic, many may scratch their heads at the fuss over inflation. For those who remember the 27 per cent inflation of summer 1975, 2.8 per cent might hardly seem worth bothering about.

Yet public awareness of inflation is starting to have an impact on our personal finances. For example, National Savings & Investments (NS&I), the Government-backed savings body, reports a huge inflow of cash into its "inflation-proof" tax-free savings certificates. It has sold £170m in the first two weeks of this month, putting it on track to record its biggest monthly sale ever.

"January set a new record," a spokeswoman says, "with over £196m invested in that month alone, but May will likely beat that."

Two years ago, NS&I rebranded its savings certificates, describing them as "inflation-beating" rather than "index-linked". It currently pays interest at 1.35 per cent above the retail price index, giving savers an annual return of 5.85 per cent.

Justin Modray of the independent financial adviser Bestinvest believes that fear and distrust of the stock market is another reason for the popularity of savings products like NS&I's.

"The sea change comes from people using their annual individual savings account [ISA] allowance on cash instead of equities," he says.

Equity investors can put £7,000 a year into tax-free maxi ISAs. But the individual allowance for mini cash ISAs is only £3,000 and so is used up much more quickly. "This leaves more cash for NS&I products," notes Mr Modray. "In essence, people are still wary of volatility in the stock markets."

They also fear the spectre of inflation, with its capacity to destroy their purchasing power. To arm themselves against it, they are turning to sources of information such as the "personal inflation rate" website www.statistics.gov.uk/pic, launched in February by the Office for National Statistics. This tool allows you to pick out goods on which you spend the most money, and so calculate your own inflation rate; so far, more than 120,000 visitors to the site have done so.

Initiatives like this respond to criticism from consumer groups that inflation as measured by the consumer price index - which, unlike the retail price index, does not include mortgage interest costs - can never accurately reflect individuals' spending habits.

Figures from Bestinvest show how even low rates of inflation can erode the value of your cash. At just 2.8 per cent, it can turn £2,000 into £1,506 over 10 years.

"Sadly, the vast majority of people don't understand the impact of, or care about, inflation," says Mr Modray. "To be fair, most are more worried about paying the bills. But if you are saving money, you must keep inflation in mind."

Even though inflation is now falling, to make real returns, basic-rate taxpayers need to stash their money in an account that pays at least 3.5 per cent interest; for higher-rate earners, it should be 4.67 per cent.

According to the financial analyst Moneyfacts, of 629 savings accounts available in the UK, just 331 pay 3.5 per cent or above, and only 175 pay 4.67 per cent or above.

It's not just savings accounts that are affected. Annuities (the annual income for life purchased with the proceeds from a pension pot) can be "inflation proofed" - but this protection comes at a price.

Under such a deal, a 65-year-old non-smoker with a £100,000 pension pot will get £392 a month from Prudential, rather than £602 without inflation proofing - and only £389 instead of £594 from Legal & General (based on Financial Services Authority figures).

But inflation isn't all bad. When house prices soar, the cost of mortgage repayments falls in real terms, as each month you are paying less in proportion to the rising value of the property.

Compare and save on money, insurance and energy deals at Independent Compare