Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Eurozone Inflation Is Stubbornly Sticky
Transcript
- Lucas: So we keep hearing that eurozone inflation is coming down, and it is — headline was what, two point three percent last reading? But the numbers that actually hit people's monthly budgets are still running hot. Services inflation is stuck near four percent. Luna: Four percent? That's more than double the ECB's target. So the headline number is flattering, but the underlying pressure is still there. Lucas: Exactly. And that's the story I want to dig into today — why this 'last mile' of inflation is turning out to be a slog. It's not about energy or supply chains anymore. It's about wages, and services, and the fact that the labor market is still tight in a way that keeps pushing prices up. Luna: And this is exactly what the ECB is wrestling with as they head into their September meeting. Markets are pricing in a pause, but the data is making that pause look riskier. Lucas: Right. Let's look at the numbers. In the latest flash reading, services inflation was three point nine percent year-over-year. That's down a touch from earlier, but it's been hovering in that high-three, low-four range for months. Meanwhile, goods inflation has basically collapsed — it's near zero or even negative in some categories. Luna: So we've got this split economy. Goods are cheap because supply chains have healed and demand is cooling, but services are expensive because labor is the main input, and wages are still climbing. Lucas: And that's the crux. Services inflation is labor cost inflation. When wages go up by four or five percent, businesses pass that on. And the ECB is stuck — they want to cool wage growth, but they can't do much about it with interest rates alone if the labor market stays this tight. Luna: But why is the labor market still so tight? I mean, growth has slowed — GDP growth annualized dropped to one point five percent from two point one. Shouldn't that loosen things up? Lucas: You'd think so, but look at the details. Unemployment in the eurozone is still at historic lows, around six point four percent. And a lot of the slowdown is coming from industry — manufacturing is weak, but services are still adding jobs. So the mix is shifting, not collapsing. Luna: So we have a services sector that's still hiring, still raising wages, and still passing those costs on to consumers. And the ECB's rate hikes haven't really filtered through to that part of the economy yet. Lucas: That's the transmission lag. Rate hikes hit interest-sensitive sectors — housing, construction, big-ticket goods — pretty quickly. But services are more resilient. People still need haircuts, restaurant meals, and travel. And with wages rising, they can afford them. Lucas: We're also seeing this in the inflation data by country. Germany, which is more manufacturing-heavy, has headline inflation below two percent. But France and Spain, where services are a bigger share, are running closer to two point five or three percent. Luna: So this isn't just a eurozone-wide phenomenon — it's got a geographical dimension. And that makes the ECB's one-size-fits-all policy even harder. Lucas: Exactly. And then there's the euro itself. It's been holding around one point one six against the dollar. That's actually providing some tailwind by keeping import prices low, but it also reflects the relative strength of the eurozone economy compared to the US, which is slowing more sharply. Luna: Interesting — so the strong euro is both a blessing and a curse. It helps fight inflation, but it also signals that the ECB might be less inclined to cut rates aggressively. Lucas: Exactly. And that's the dilemma. Markets are pricing in two or three more cuts over the next year, but if services inflation stays sticky, the ECB might have to hold off. And that would push back on those expectations. Luna: Before we go deeper into the policy side, I want to pause for a second. You know, we do this show every day, and we don't run ads. That's a deliberate choice — we want to keep this free and independent. If you've been getting value from these episodes, and you want to support that, you can find us at buy me a coffee dot com slash fexingo. It's a small way to keep us going. Lucas: Yeah, it genuinely helps. No pressure, but if you've ever learned something from this show, that's the way to keep it coming. Now, back to the ECB — what are they actually likely to do in September? Luna: Right, so the consensus is a pause. But there's a camp arguing that they should hike again because services inflation is still too high. And that camp is getting louder. Lucas: I think the ECB is in wait and see mode. They've hiked rates a lot over the past couple of years — the deposit rate is at four percent — and they want to see the full effect of that. But they're also watching the wage data closely. If the next round of wage negotiations comes in hot, they'll have to act. Luna: And what about the bond markets? Yields have been volatile — the ten-year Bund is around two point eight percent. That's up from last year, and it reflects that investors are starting to price in a longer period of higher rates. Lucas: Yeah, longer-term yields are rising because markets realize that the ECB won't be able to cut as quickly as they hoped. And that's actually a problem for governments with high debt levels — Italy, for example, is paying more to service its debt. Luna: So we have a fragile situation. Sticky services inflation, tight labor markets, and fiscal pressures in the periphery. The ECB is walking a tightrope. Lucas: And that's what makes this so interesting. If they cut too early, inflation could re-accelerate. If they wait too long, they risk a deeper slowdown. And the data isn't giving them a clear signal. Luna: What about the consumer side? Are people actually feeling this? I saw a headline about lettuce prices plunging because of a cyclospora scare — that's a health issue, but it shows how food prices can be volatile. Lucas: Right, food is always volatile. But the sticky part is services. Your rent, your insurance, your restaurant meals — those are the things that keep going up. And that's what people feel in their daily lives, even if the headline inflation number looks tame. Luna: So what should an investor be watching? If services inflation stays sticky, what does that mean for eurozone equities or the euro? Lucas: Well, if the ECB holds rates higher for longer, that's good for the euro — we've seen it around one point one six against the dollar. But it's a mixed bag for stocks. Banks tend to benefit from higher rates, but rate-sensitive sectors like real estate and utilities could struggle. Luna: And what about the consumer? If wages keep rising, that supports spending, but if inflation eats into those gains, people might start to tighten their belts. Lucas: It's a balancing act. Real wages have actually turned positive recently — wages are growing faster than inflation now. That's a good sign for consumption. But it also feeds back into services inflation, which is the problem. Luna: So we're kind of stuck in a loop. Wages go up, prices go up, wages go up to catch up, and the ECB has to try to break that cycle. Lucas: Exactly. And breaking that cycle is painful. It might require a period of below-trend growth and maybe even a mild recession. That's the price of getting inflation back to two percent. Luna: Do you think the ECB is willing to pay that price? They have a dual mandate, but price stability is their primary goal. Lucas: I think they are. Christine Lagarde has been pretty clear that they're committed to bringing inflation down. But there's a limit to how much they can do if the economy starts to deteriorate significantly. They don't want to cause a recession if they can avoid it. Luna: So it's a reactive stance. They'll wait for the data, and if the data forces their hand, they'll act. Lucas: Yeah. And that's why the next few months are crucial. We've got the September meeting, then the October one, and all the while we'll be watching wage negotiations in Germany and France. The outcome of those will really shape what happens next. Luna: So what's your take? Are we going to see services inflation come down anytime soon, or are we in for a long, slow grind? Lucas: I think it's going to be a grind. The labor market is still too tight, and the structural factors — demographics, the shift toward services, the fact that people are spending more on experiences — are all supportive of higher services prices. I don't see that changing dramatically over the next year. Luna: So buckle up. The last mile is going to be the longest. Lucas: Exactly. And for the ECB, that means they have to stay vigilant. They can't let their guard down just because the headline number looks okay. The battle isn't over until services inflation is back to something like two percent.