ECB Insight: Governing Council Sees Services Inflation as Potential Spanner in the Works
16 January 2025
By Marta Vilar – MADRID (Econostream) – Since the European Central Bank's monetary policy meeting of 12 December, a significant number of Governing Council members have been conspicuously hesitant to celebrate an immaculate disinflation for a common reason: the ongoing threat posed by high services inflation.
While Eurozone headline inflation is seen as having consolidated its downtrend to 2% despite December’s widely expected uptick to 2.4%, inflation in the services sector has persisted around 4%, almost double the headline figure.
‘For [headline] inflation to be at our target of 2% sustainably, there would need to be a further decline in services inflation from around 4% today’, Chief Economist Philip Lane said in an interview on Monday.
That condition argued for a gradual approach to easing, he said: ‘If interest rates fall too quickly, it will be difficult to bring services inflation under control.’
At the other end of the hawk-dove spectrum, Executive Board member Isabel Schnabel echoed Lane’s views in a speech on December 16, when she observed that services inflation momentum had let up somewhat but cautioned that ‘such signals critically depend on the way the seasonal adjustment is done.’
‘So, even if most of the evidence points to continued disinflation, we should remain alert to signs that cast doubt on our baseline’, she continued. ‘A gradual approach allows us to react to such signs.’
Services inflation was cited as ‘a problem’ by Croatian National Bank Governor Boris Vujčić when asked in an interview by Econostream last week if the disinflation process could stall in Europe as it had in the US and the UK.
‘There's a risk’ he replied. ‘Services inflation is a problem, which is why domestic inflation is still so stubborn.’
Base effects alone should erase two percentage points of sector inflation this year, according to Vujčić. However, this did ‘not necessarily’ mean the number would fall from 4% to 2%, as new inflation could be generated, he warned.
Some policymakers have suggested that services inflation is an obstacle to declaring victory in the battle against inflation.
ECB President Christine Lagarde told the FT in a podcast on December 23 that despite being ‘closer’ to declaring victory over inflation, she had to say that ‘with a little reservation’, because the central bank still had to be ‘very vigilant about services.’
Another example is Central Bank of Ireland Governor Gabriel Makhlouf, who last month said that monetary authorities ‘haven’t declared victory yet’ as ‘some elements’ of services inflation remained ‘a bit’ concerning.
For Banco de España Governor José Luis Escrivá, services inflation is ‘probably the most important component of underlying inflation’ and still too high.
Belgian National Bank Governor Pierre Wunsch echoed the latter thought and said the level of this indicator was the reason why the risk of undershooting had not increased recently.
Clarity about inflation could arrive as soon as in the first half of 2025, according to Governor Vujčić. But for now, services inflation still threatens to be a spanner in the works of the disinflation process.