Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Eurozone Services Inflation Is Running Hot in 2026
Transcript
- Lucas: So it’s Wednesday, June 11, and the ECB meets tomorrow. The headline inflation number for May came in at 4.2 percent, which is the highest in three years. But what’s interesting is that energy prices actually dropped year-over-year. The real story is services inflation, which is running at 4.5 percent across the eurozone. That’s the highest since at least the early 2010s. Luna: It feels like every time I get a haircut in Berlin, it’s noticeably more expensive than the last time. And I’m not alone — my friends in Lisbon say the same about restaurant prices. Lucas: Exactly. Services inflation is sticky because it’s driven by wages and domestic demand, not by global commodity prices. In Spain, services inflation hit 5.1 percent in April, driven largely by tourism. Hotel rates in Barcelona are up nearly 12 percent year-over-year. Luna: And that feeds straight into core CPI. If you strip out energy and food, core inflation is still above 3 percent in most eurozone countries. The ECB has been hoping it would fade, but it’s stubborn. Lucas: That’s the tension. If walking through the economy with us has made something click, a couple of dollars a month is genuinely what keeps these going. Buy me a coffee dot com slash fexingo, if you’ve gotten something out of them. Luna: Yeah, it really does help us keep the show ad-free and focused on the numbers. And it’s a small way to say the episodes matter. Lucas: Alright — back to the services inflation puzzle. One reason it’s so persistent is that the labor market is still tight. Unemployment in the eurozone is at a record low of 6.4 percent. In Portugal, it’s below 6 percent. That means workers in hospitality and personal services have leverage to demand higher wages, and businesses pass those costs on. Luna: But manufacturing is a different story. Germany’s industrial production fell 0.4 percent in April, and factory orders are down. So you’ve got this two-speed economy: services booming, manufacturing stagnating. Lucas: That split makes the ECB’s job harder. If services inflation stays hot, they may feel compelled to hike rates again tomorrow, even though the industrial sector is weak. The market is pricing in a 25-basis-point increase, taking the deposit rate to 4.25 percent. Luna: And the hawks on the Governing Council will point to that 4.5 percent services CPI as evidence that they can’t stop yet. Isabel Schnabel gave a speech last week saying core inflation is proving more persistent than anticipated. Lucas: Right. And it’s not just wages. There’s also the fact that services are less exposed to global competition. A haircut in Milan isn’t going to be undercut by a haircut in Shanghai. So domestic demand and local labor costs matter much more. Luna: So where does services inflation go from here? If tourism continues to rebound — and it is, especially with Chinese travelers returning to Europe — then prices in hospitality could keep rising. We might not see services inflation drop below 3 percent until 2027. Lucas: That’s a scary thought for the ECB. They’ve been hoping that the lagged effect of previous rate hikes would cool the economy. But services are interest-rate insensitive compared to housing or manufacturing. People still need to eat out, get haircuts, go to the dentist. Luna: And the ECB’s own survey of consumers shows that one-year-ahead inflation expectations rose to 3.8 percent in May. That’s dangerously high. If people expect prices to keep rising, they’ll adjust their behavior accordingly — demanding higher wages, which then feeds back into services inflation. Lucas: That’s the wage-price spiral risk. And it’s exactly what the ECB wants to avoid. Lagarde has said repeatedly that they need to break the back of inflation expectations. A rate hike tomorrow would be a signal that they’re serious. Luna: But what about the doves? Some council members might argue that the economy is weakening and that hiking further could tip the eurozone into recession. Especially if manufacturing continues to deteriorate. Lucas: And that’s the classic central banker dilemma. You have to look through the volatile headline number and focus on the persistent components. Services inflation is the persistent component right now. So I think they hike tomorrow, but with a dovish tone — indicating that this might be the last one if data turns. Luna: Let’s look at a specific example. In Portugal, the national statistics institute reported that restaurant and hotel prices rose 7.2 percent year-over-year in April. That’s way above the eurozone average. Why Portugal specifically? Lucas: Portugal is a great case. It’s become a hotspot for digital nomads and tourists, which has driven up demand for services. At the same time, the country has a relatively small labor force, so wage pressures are intense. The minimum wage there was increased by 7.8 percent in January. That directly feeds into services prices. Luna: And it’s not just low-end services. Even professional services like legal advice, accounting, and consulting are seeing fee increases of 4 to 5 percent. That’s going to filter through to business costs and eventually to consumer prices. Lucas: So the inflation is broad-based within services. The ECB’s分解 shows that recreation and personal care services are up 4.8 percent, transport services up 3.9 percent, communication up 2.1 percent. It’s not just one outlier category. Luna: And the US is seeing a similar phenomenon. The May CPI report there also showed services inflation running hot. Core services ex-housing in the US is up 4.6 percent year-over-year. So this is a developed-economy problem, not just eurozone-specific. Lucas: That’s a good point. The Fed is dealing with the same issue. But the eurozone has the added complication of being a monetary union with different fiscal stances. Some countries are running expansionary budgets, like Italy with its generous tax credits for home renovations, which is boosting demand. Luna: And that fiscal divergence makes the ECB’s one-size-fits-all policy even more challenging. A rate hike that might be appropriate for Germany’s services inflation could be too tight for Greece’s still-recovering economy. Lucas: Let’s bring it back to the numbers. The eurozone GDP growth rate for 2026 Q1 was 1.6 percent annualised. That’s not terrible, but it’s below potential. And if the ECB keeps tightening, that growth could slow further. The trade-weighted euro has also strengthened, which is a tightening in itself — the US dollar index is at 120, and the euro is at 1.15 dollars, so eurozone exports become less competitive. Luna: So the ECB is between a rock and a hard place. If they don’t hike, services inflation stays high and expectations become unanchored. If they do hike, they risk crushing the fragile industrial recovery. What’s your call? Lucas: I think they hike 25 basis points tomorrow, but soften the forward guidance. They’ll acknowledge that services inflation is persistent but say that the full effects of previous hikes are still working through. That way they keep their hawkish credibility while leaving the door open to pause. Luna: And what does that mean for the average person listening? If you’re planning a trip to Europe this summer, expect hotel and restaurant prices to be significantly higher than last year. And if you’re a European consumer, your cost of living is still rising faster than your wage, especially in services. Lucas: That’s the reality. The services inflation story is not going away quickly. We’ll be watching the ECB statement tomorrow at 1:45 PM Central European Time, and then Lagarde’s press conference at 2:30. That should give us more clarity on their thinking. Luna: And we’ll be back with a reaction episode on Thursday. For now, the key takeaway is that services inflation is the new frontier in the ECB’s fight against inflation, and it’s proving to be a tough nut to crack. Lucas: Exactly. Thanks for listening, and we’ll talk to you soon.