Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Eurozone Services Inflation Is the ECB's Next Test
Transcript
- Lucas: So the ECB has been telling us for months that the last mile of inflation would be the hardest, and the August data is proving them right. Services inflation in the eurozone is running at around 4 percent, more than double the overall target, and it's barely budged all year. Luna: And yet the headline number keeps falling. It's that gap that's got everyone watching the September meeting. Lucas: Exactly. And look, before we go deeper, I want to be honest about something. A small group of listeners keeps this show going through buy me a coffee dot com slash fexingo. No ads, no sponsors, just people who find the economics useful. Luna: Yeah, and it genuinely makes a difference. If you've ever gotten something out of our breakdowns, that's the way to keep it ad-free. Lucas: Right, so back to the numbers. The July PMI for services came in at 51.9, still in expansion, but the prices charged index ticked up again. That's the forward-looking signal that services inflation isn't fading on its own. Luna: And it's not just one country. Are we seeing this broadly? Lucas: Broadly, yeah. But with real variation. Germany's services inflation is hovering around 3.5 percent, while Spain is closer to 4.5. The common thread is wages. The ECB's own tracker shows negotiated wage growth running at 4.3 percent year-over-year, and that feeds directly into labor-intensive services. Luna: So the question is, how much of that wage growth is catch-up from the inflation shock, and how much is a new normal? Lucas: That's the million-euro question. The ECB's chief economist has been arguing that profits absorbed some of the wage hit, which should cool things down. But the data isn't showing that yet. In the latest round of corporate earnings calls, you're hearing more companies talk about passing higher labor costs through to prices. Luna: And that's why the ECB is being so careful. They don't want to declare victory on inflation only to see a second wave. Lucas: Right. The market's currently pricing in a hold in September, with maybe one more cut in December. But if services inflation stays above 4 percent, that December cut starts to look shaky. Luna: So what would actually break the stickiness? Would it take a recession? Lucas: Historically, services inflation responds to slack in the labor market, and there's barely any slack right now. The unemployment rate is at a record low of 6.3 percent. You'd need a meaningful slowdown to loosen that, and that's a painful trade-off. Luna: But the economy is still growing. Real GDP growth at the eurozone level is around 1.5 percent annualized, so we're not exactly on the brink. Lucas: No, and that's what makes it tricky. The ECB is trying to cool inflation without choking off growth that's finally decent. And the currency complicates things. The euro's been holding around 1.16 against the dollar, which is actually helping by keeping import prices down. But that also means less of a tailwind from currency depreciation to boost exports. Luna: So it's a delicate act. What are you watching for between now and the September meeting? Lucas: The flash PMI for September, the August CPI print, and any commentary from the ECB's speakers at Jackson Hole. If they sound more concerned about services inflation, you can bet the hawks will push back on any talk of cutting before year-end. Luna: And the market's already jittery about that. You've got rate-cut expectations being pared back, and that's showing up in bond yields. Lucas: Right. The ten-year German Bund yield has ticked up to 2.4 percent, and that's a direct reflection of the market repricing. Investors are starting to realize that the last mile isn't a sprint, it's a plateau. Luna: So one concrete thing listeners can take away: if services inflation stays above 4 percent, the ECB is unlikely to cut in December. Is that the takeaway? Lucas: That's the crux. And it's why the ECB keeps saying they're data dependent. Every whisper from the PMI or the wage tracker is going to move the needle. Luna: Well, we'll be watching. Thanks for breaking it down. Lucas: Always. And if this episode helped you get a clearer picture, that's what we're here for.