Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Europe's Sticky Services Inflation Is the ECB's Real Test
Transcript
- Lucas: So, the euro is sitting at one point one six against the dollar, pretty much flat over the past week. But the real story in Europe isn't the currency, it's services inflation. And that's the number the ECB keeps staring at. Luna: Services inflation, that's the sticky one, right? The stuff that doesn't go away even when headline numbers start behaving. Lucas: Exactly. And it's the number that's keeping the ECB up at night. Because while goods inflation has cooled off, services are still running hot, and that's largely a wage story. Luna: Wages. The thing that's always the last to adjust. So what are we looking at? What's the actual number? Lucas: So, the latest data from August 2026 shows services inflation in the Eurozone still hovering around four percent, while headline inflation is closer to two and a half. That gap is the problem. And it's not just one country, it's across the board. Luna: So it's not just a German thing or a French thing. This is a euro area-wide phenomenon. What's driving it? Lucas: A big part is labor costs. The labor market is still tight. Unemployment is at historic lows, and workers are getting wage increases that are feeding into prices. And unlike goods, services are harder to substitute. You can't just import a haircut. Luna: Right. You can't arbitrage a haircut. So the ECB is stuck, because they have to decide how much of this is transitory and how much is structural. Lucas: Exactly. And that's why their job is so delicate. If they overreact and raise rates too much, they risk killing the recovery. But if they underreact, inflation expectations could get unanchored, and that's a much worse problem. Luna: And we've seen some of that play out in the US. The Fed has been dealing with similar dynamics. But what's different here? Why is Europe's services inflation so sticky? Lucas: One thing is the structure of the labor market. In Europe, you have more collective bargaining, minimum wage increases that are indexed, and that makes wage growth more persistent. Plus, you have the legacy of the pandemic, where a lot of service sector jobs were lost, and now there's a labor shortage in some areas. Luna: So it's a supply-side problem. Not enough workers in certain sectors, which drives up wages, which drives up prices. Lucas: Right. And the ECB has been watching this closely. They've been talking about the importance of wage data, and they've signaled that they want to see wage growth cool before they feel comfortable with inflation returning to target. Luna: But wage growth is still running at what, around four percent? That's not cooling much. Lucas: It's not. And that's the dilemma. The ECB is walking a tightrope, and every data release feels like it could tip them one way or the other. Luna: So, with all this going on, I'm curious what the market is pricing in. Are they expecting more rate hikes? Lucas: Market expectations have been all over the place. Earlier this year, there was talk of cuts. Now, with services inflation persisting, the conversation has shifted. It's no longer a question of if they cut, but when, and how much. Luna: And there's the whole debate about whether they're behind the curve or ahead of it. It's a classic central bank dilemma. Lucas: Yeah, and you know, it's interesting because we talk about this on the show, and we try to make sense of it for our listeners. And I think it's worth remembering that we're able to have these conversations without ads, because of listeners who support us. If you find value in what we do, you can support us at buy me a coffee dot com slash fexingo. It's a simple way to keep the show independent and ad-free. Luna: Yeah, it really makes a difference. Thanks to everyone who does. But back to the ECB, we were talking about how services inflation is the real test. Lucas: Right. So let's look at some of the specifics. The ECB's latest projections, from June, had inflation averaging two point two percent this year, and one point nine in 2027. But that assumes services inflation eases. If it doesn't, those projections could be too optimistic. Luna: And what about the euro itself? A weaker euro makes imports more expensive, which feeds into inflation. But the euro has been relatively stable lately. Lucas: It has, and that's actually helping. The trade-weighted dollar index has been drifting down, and the euro is holding up. That means imported goods inflation isn't adding to the pressure, which gives the ECB a little more room to wait. Luna: But waiting can be risky too. If they wait too long, inflation expectations could become entrenched. Lucas: Exactly. And that's what makes this so tricky. They have to balance the risk of doing too much versus too little. And the data is genuinely mixed. You have wholesale prices flat in the US, which might suggest global inflation pressures are easing, but services inflation in Europe is still running hot. Luna: So, what would be the trigger for the ECB to act more aggressively? What should we be watching? Lucas: I'd look at two things. First, the wage data, especially the negotiated wage numbers, which come out quarterly. Second, the inflation expectations surveys, both for consumers and businesses. If those start to drift up, the ECB will have no choice but to act. Luna: And what about the upcoming meeting in September? Is there any chance they surprise us? Lucas: It's unlikely they'll move in September, but the guidance they give will be important. They might set the stage for a move later in the year. The market is pricing in a cut by December, but honestly, I think it's a coin flip. Luna: So, for the average person in Europe, what does this mean? We keep hearing about inflation, but what's the practical takeaway? Lucas: It means that the cost of services, from dining out to getting your car repaired, is likely to keep rising at a faster pace than goods prices. That's the immediate impact. And if the ECB has to keep rates higher for longer, that means mortgage rates and business loans stay elevated. Luna: So, it's not just an abstract macro thing. It affects people's daily lives. Lucas: Absolutely. And that's why we're spending so much time on it. It's one of the most important economic challenges facing Europe right now, and it's not going to be resolved overnight. Luna: Well, we'll be watching the data closely. Thanks for breaking it down, Lucas. Lucas: Always a pleasure. And for our listeners, if you want to dig deeper into the numbers, check out the show notes. We'll have links to the data and some of the research we mentioned.