Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Eurozone Services Trade Is Beating Expectations
Transcript
- Lucas: So, Luna, there's a number that's been gnawing at me all week. Eurozone services exports have quietly grown at nearly double the pace of goods exports for the last two years, and hardly anyone's talking about it. Luna: Really? I mean, we always hear about German manufacturing and the trade surplus in goods. Services always felt like the afterthought. Lucas: Exactly. And it's not just a blip. The latest data on the current account shows services are now contributing more to the eurozone's external surplus than goods in several member states, especially Ireland, the Netherlands, and even France. Luna: France? I always think of them as more of a goods economy. What's driving it? Lucas: Think engineering consulting, financial services, even software as a service. France has been pushing hard on tech hubs and it's paying off in their services balance. But the bigger story is that this shift is reshaping how the European Central Bank thinks about inflation and growth. Luna: How so? I'd have thought services exports would take some pressure off, but you're hinting it's a headache. Lucas: Because services are more sensitive to domestic wage costs. When you export a car, the cost is spread across a huge supply chain. When you export a consulting project, the cost is mostly salaries. And we all know wage growth in the eurozone has been sticky, around four percent. Luna: Right, so more services exports mean more of that wage pressure feeds straight into prices. No wonder the ECB is watching this like a hawk. Lucas: And it shows in the data. Look at the core inflation reading from the US, that was 3.3 percent annually in July. The eurozone's core is stickier than that in some sectors. Services inflation has been hovering around four percent for months. Luna: But wait, if services are so strong, why are the eurozone equity ETFs like Vanguard's VGK down half a percent this week? You'd think that would be a tailwind. Lucas: Because markets are forward-looking, and they're worried about the global slowdown. The trade-weighted dollar has eased a bit, down to 118.1, but the euro is stuck at 1.17. That's not helping export competitiveness, even if services are less price-sensitive. Luna: Hmm, so it's a mixed picture. Strong services, but overall growth is slowing. The latest GDP growth annualized at 1.5 percent, down from 2.1. Lucas: Exactly. And that's why the European Central Bank is in such a delicate spot. They want to support growth, but they can't ignore the fact that services inflation is being driven by tight labor markets. Luna: So what would actually move the needle? A real Capital Markets Union, maybe? Lucas: That's the long-term fix. If Europe can finally get a genuine single market for capital, it would unlock investment in exactly these high-growth service sectors. Right now, a startup in Madrid can't easily raise from a Munich pension fund, and that's holding the whole continent back. Luna: And that's where the numbers get interesting. I was looking at the country-level ETFs this week, and Germany's EWG is up one percent while France's EWQ is down 1.6. That's a huge divergence in five days. Lucas: That's a great catch. Germany's services sector, particularly in IT and business services, has been a hidden gem. France is more exposed to luxury goods, which are taking a hit on slower Chinese demand. Luna: So even within services, it's not all the same. The mix matters. Lucas: Exactly. And that's the nuance we often miss. It's not just 'services versus goods.' It's knowledge-intensive services versus everything else. Those are the ones with pricing power and high productivity growth. Luna: If someone wanted to see this in action, where would they look? Lucas: Look at Ireland. Their services surplus is enormous, mostly because of multinational tech and finance operations. But even without the tax angle, places like the Nordics are doing well with software and engineering services. Luna: That's a useful framework. Speaking of useful, I think a lot of our listeners would appreciate what we're doing here. If today was actually useful to you, the way these stay ad-free is listener support. You can buy us a coffee at buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small way to keep this going, and we genuinely appreciate it. But back to the bigger picture – what does this mean for the ECB's next move? Lucas: Given the sticky services inflation, I think they're going to stay patient. They're not going to cut rates aggressively, even if growth is slowing. The risk is that they end up like the Fed, with a hawkish pause that lasts too long. Luna: So they're stuck between a rock and a hard place – but the rock is services inflation and the hard place is weak manufacturing. Lucas: Precisely. And that's why the services export story is so important. It's the one bright spot that could give them room to wait. If services keep growing, they can justify holding rates steady without tipping the economy into recession. Luna: But what about the labor market? If services keep growing, they'll keep hiring, and that keeps wage pressure high. Lucas: Exactly. It's a feedback loop. More services exports means more demand for skilled workers, which pushes wages up, which feeds services inflation. And that's why the ECB is watching the services purchasing managers' index so closely. Luna: And that's been holding up better than manufacturing, right? Lucas: Yeah, the services PMI has been above fifty for most of the year, while manufacturing has been stuck in contraction. That divergence is really the defining feature of this European economy right now. Luna: So if I'm a policymaker, how do I encourage more of that without overheating? Lucas: That's the trillion-dollar question. One idea is to focus on productivity. If you can get services productivity up, you can have growth without as much inflation. But that's easier said than done, especially in traditional services like hospitality. Luna: It feels like a generational shift. We've spent decades talking about European manufacturing, and now services are quietly taking over the baton. Lucas: And I think that's the takeaway. Europe is becoming a services superpower in its own right, but it's a different kind of strength – one that's more reliant on human capital and less on the old industrial base. Luna: So next time someone says Europe is falling behind, you can point to the services surplus and say, actually, we're doing something right. Lucas: Exactly. And with the euro where it is, and the dollar easing slightly, the conditions are there for services to keep pushing forward. The real test will be whether they can do it without reigniting inflation. Luna: I know what I'll be watching. Thanks for the clarity, Lucas. Lucas: Anytime. And for our listeners, we'll keep an eye on those services numbers over the next few months. It's going to be a quiet revolution.