Policymakers could take urgent action to ease fears that excessive inflation will damage Britain’s post-coronavirus recovery.

Inflation has reached its highest level since 2012, hitting 3.2pc in August after food prices, second hand cars and petrol costs all pushed the average level of prices and pulled down the value of money.

The Bank of England's Monetary Policy Committee has said it expects inflation to reach 4pc before the end of 2021.

What happens when inflation rises?

High inflation can have a devastating impact on the nation’s personal finances. Inflation measures the average level of prices increases across the country.

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.

Can cash savings beat inflation?

Despite inflation hitting 3.2pc, many high street banks are now paying as little as 0.01pc in interest on their accounts. On a balance of £50,000, this would earn just £5 a year.

The effect of 3.2pc inflation is devastating. Even with the interest, the real value of this £50,000 reduces to £48,400 after a year. If inflation persisted at this level for five years, it would be worth just £42,517.

This leaves savers with the option of investing their cash instead, locking their money away for years or watching their savings get eaten away by inflation.

No readily available easy-access accounts currently beat inflation, with the best deal, from Tandem Bank, offering just 0.65pc interest.

Locking your cash away for longer in a fixed-rate account can generate higher interest, but will still lose money in real terms. For example, the best five-year savings deal, from Atom Bank, offers 1.86pc. £10,000 in this account would lose around £759 of its purchasing power over the five years.

Will my pension pot be eaten away?

Inflation can have an enormous impact on how long retirement savings will last. Those with an annuity can see their income eroded every year if they have bought it at a fixed rate and will suffer the most from a sharp rise in inflation.

Steven Cameron, of pension provider Aegon, said “level annuities” have been the most popular in recent years, as they pay out more cash from the beginning. However, an inflation-linked annuity will start off with a much smaller income but keep increasing over time.

Mr Cameron said: “Those purchasing an annuity today are taking a risk by not linking it to inflation.”

If inflation rises even higher than the latest 3.2pc, pension savers with a “defined contribution” pension will be forced to take on more risk to keep up.

However, this inflation figure could be a boon for tens of millions of pensioners, as the state pension could get a bumper boost. The benefit will rise by 2.5pc or inflation, as measured in October, so if today's figure is anything to go by, pensioners could receive a boost next April.

However, the Government scrapped the triple lock policy of increasing the pension by highest of earning growth, inflation, or 2.5pc, after earnings growth hit 8.3pc.

Does inflation affect house prices?

Inflation poses a looming threat for the housing market because it could push the Bank of England to raise interest rates.

Buyers would have less purchasing power because mortgages would become more expensive. Kay Neufeld of the Centre for Economics and Business Research, a consultancy, said: “Interest rates have been very low for an enormous amount of time in Britain. People aren’t expecting this. The psychological impact on the market could be big.”

Demand would drop at the same time many existing homeowners would suddenly find their housing debt had become much more expensive to service.

“There is a risk for anybody on a flexible rate or on a fixed term mortgage that is coming up for renewal,” said Mr Neufeld.

The root causes of inflation will be key. The Bank of England is likely to tolerate this level of inflation if it deems to be temporary – if it is caused, for example, by short-term disruptions to supply chains or pandemic-related issues.

The Bank is only likely to act if there is set to be a long-term imbalance between supply and demand. If, for example, the rate of economic recovery is much stronger than expected.

Just as this pandemic has defied logic and pushed house prices to record highs, the recovery could therefore defy logic and depress home values.