A ladder of conventional gilts pays fixed cash amounts, so at an assumed inflation rate the purchasing power of each year's income falls — and this article works that drag year by year with the assumptions stated.
Fixed cash, moving prices
A conventional gilt pays a fixed coupon, and a ladder of conventional gilts therefore pays a set of fixed cash amounts. The pounds arrive exactly as promised. What they will buy, though, is not fixed: if prices rise, the same number of pounds buys less. That is inflation drag — the quiet erosion of an income's purchasing power when the cash is fixed and the cost of living is not. A ladder built from conventional gilts is exposed to it, because the gilts pay in cash whose real value falls as prices rise. The coupon itself never changes; it is the yardstick it is measured against that moves.
The drag is not a defect in the ladder; it is a property of any fixed-cash income. A bank account paying a fixed rate, a fixed annuity and a conventional-gilt ladder all share it. What a reader can do is see it clearly, with the assumption stated, rather than discover it years later when the same income buys less.
The assumption, not a forecast
Inflation drag is measured against an assumed rate of inflation, and that rate is an assumption the arithmetic is run on, not a forecast of what will happen. Choose 3 per cent a year and the drag is gentle; choose 6 per cent and it is steep. The figure is only as good as the assumption stated beside it, which is why any worked drag should name its rate and say plainly that it is an input. The bond ladder designer uses an inflation input too — a fixed real assumption in one mode, the reader's own figure in the other — and treats it the same way: an assumption, not a prediction. A reader can run a ladder against more than one rate, to see how sensitive the result is to the figure chosen.
The drag, year by year
The table takes a flat £10,000 a year, as a conventional ladder's coupon income might be before any inflation uplift, and deflates it to the first year's money at an assumed 3 per cent a year. The £10,000 is illustrative, the 3 per cent is the stated assumption, and the deflation arithmetic is exact.
| Year | Deflator at 3 per cent | Nominal income | Worth in year-1 money |
| 1 | 1.0000 | £10,000 | £10,000.00 |
| 2 | 1.0300 | £10,000 | £9,708.74 |
| 3 | 1.0609 | £10,000 | £9,425.96 |
| 4 | 1.0927 | £10,000 | £9,151.42 |
| 5 | 1.1255 | £10,000 | £8,884.87 |
Each deflator is 1.03 raised to the year number: 1.03 squared is 1.0609, cubed is 1.0927, to the fourth power is 1.1255. Dividing the flat £10,000 by each gives what the income is worth in first-year money. By the fifth year the same £10,000 buys about £8,885 of what it bought in year one — roughly an 11 per cent loss of purchasing power across five years at 3 per cent. At a higher assumed rate the loss is larger; at a lower one, smaller. Doubling the assumption to 6 per cent compresses the same income faster still: at 6 per cent the year-five deflator is 1.06 to the fourth power, about 1.262, so the same £10,000 would be worth about £7,921 in first-year money.
What the ladder page's real-terms chart does
The ladder page shows the same idea as a chart rather than a table. In income target mode the real-terms chart deflates future flows at a fixed 3.0 per cent a year real assumption, so each later year's cash is shown in the buying power of the first year. In lump sum mode it deflates at the inflation figure the reader enters, so the chart moves with the stated assumption. Either way the chart is showing inflation drag: the gap between the flat cash a conventional ladder pays and what that cash is worth once prices have risen.
How index-linked rungs change the picture
An index-linked gilt is built to answer this drag: its coupon and redemption are scaled by the index ratio, which rises with published inflation, so the cash it pays grows rather than staying flat. A ladder of index-linked rungs therefore tracks inflation instead of being eroded by it, though at the cost of a lower starting real coupon. The RPI curve page shows the inflation the market is pricing across maturities, which is the market's implied rate rather than a forecast, and it is the natural comparison for an assumed rate in a drag calculation. A mixed ladder — some conventional rungs, some index-linked — sits between the two. The choice is not about which is better but about how much inflation protection a reader wants to pay for in a lower starting real coupon.
Background, not advice
This article shows how to measure inflation drag on a fixed-cash ladder income, with the assumption stated. It is general background on how the figures are put together, not investment, tax or legal advice for any reader's circumstances. The 3 per cent rate above is an assumption the arithmetic is run on and not a forecast, and the £10,000 income is illustrative. The primary source for a real inflation rate is the Office for National Statistics, and for a real gilt's terms the gilt's own record and the Debt Management Office; GOV.UK and HMRC are the source for a tax rule.