Services Under Pressure

In recent years, inflation has reclaimed center stage in the economic debate. But behind the headline numbers lies a divergence between goods and services, with major implications for monetary policy. “Today, it’s services — driven by wages and domestic demand — that are sustaining inflation in Europe,” explains Mario Porqueddu, Bocconi alumnus and Senior Economist at the European Central Bank. Understanding these sectoral dynamics is crucial for central banks aiming to respond effectively in an increasingly uncertain environment.

In your recent piece for the ECB Economic Bulletin, you explored the divergence between goods and services inflation. Why is it important to distinguish between the two? And what do these trends reveal about how the economy works?

The ECB’s primary objective is price stability measured in terms of total inflation. Yet trends in relative prices are informative for the likely persistence of a shock and for gauging the impact of secular forces on inflation. The gap between services and non-energy industrial goods (NEIG) inflation varies over time, but it had remained positive for a long period until the 2021-2022 inflation surge. Prices of goods are influenced more by global production and trade conditions and the manufacturing sector has seen a superior productivity performance compared to services, which can explain part of these pre-pandemic trends in relative prices. These dynamics reveal that the economy reacts differently to global versus domestic shocks, with services inflation showing greater persistence due to its dependence on wages and domestic demand.

What are the main factors explaining the differing behavior of goods and services inflation? Energy, wages, domestic demand: what plays the biggest role today?

Goods inflation is historically driven to a large extent by energy prices, global supply chains and external factors compared to services. The box highlights that supply-side shocks (e.g. energy prices, supply chain disruptions) had a stronger, quicker, but less persistent effect on NEIG inflation in 2022 and 2023. On the other end, services inflation is driven more by labor market dynamics (e.g. strong wage pressures) and domestic demand. While goods inflation came down strongly due to fading of supply shocks, services inflation has been more persistent due to persistent wage pressures and tight labor markets. Thus, services inflation, driven by domestic factors, plays a bigger role in overall inflation today compared to goods.

Are the differences we are seeing between goods and services temporary, linked to recent shocks, or do they signal a more structural change in inflation dynamics?

The divergence between goods and services inflation is influenced by both temporary shocks and potential structural changes. Pandemic-related disruptions and energy price surges caused a temporary reversal of the usual positive gap between services and goods inflation. The positive inflation gap between services and goods is returning to its historical level, but demographic trends (e.g. aging), technological advancements (e.g. AI), and deglobalization could lead to structural shifts in relative prices. Labor-intensive services may face continued upward price pressures. Goods inflation could also increase with a possible deglobalization due to geopolitical and trade fragmentation. Digitalization and developments in artificial intelligence (AI) could affect services and goods prices differently. The size of the overall effect remains uncertain and depends on how quickly these technologies are adopted in the production process. 

Over the past three years, inflation has returned forcefully to the center of economic debate. A temporary spike was expected, but services inflation seems more persistent. Is this an anomaly or a warning sign?

While goods inflation has normalized following the unwinding of supply shocks, services inflation was slower to come down, due to still strong wage pressures and labor market tightness.  According to the June 2025 Eurosystem projections, services inflation is expected to decline gradually, reflecting the fact that the delayed adjustments to earlier general price increases are fading out and the moderation in labor cost pressures is feeding through.

How does the ECB’s work change when inflation is not homogeneous but scattered across sectors? Does it make monetary policy calibration more difficult?

An in-depth understanding of the drivers of the prices of different types of goods and services is paramount. Goods inflation responds more quickly to external shocks and policy measures, while services inflation is more persistent due to its reliance on wages and domestic demand. This heterogeneity requires a careful monitoring of sectoral dynamics. 

For many people, headline inflation figures often feel disconnected from daily life. Can the difference between goods and services inflation help explain this gap?

The public’s perceptions of inflation are influenced by the prices of frequently purchased items. In particular, energy and food tend to dominate the public’s perception on inflation because they are purchased more frequently and are more visible to consumers. 

Expectations play a crucial role in how monetary policy is transmitted. How are inflation expectations formed today, and how responsive are they to ECB communication?

The drivers of expectations vary depending on the time horizon for which they are formed. Short-term expectations are more sensitive to past inflation shocks, while long-term expectations are more linked to the central bank’s inflation target. Long-term expectations in the euro area remained anchored during the 2021-2022 inflation surge, reflecting confidence in the ECB's ability to manage inflation.

After years of low and stable inflation, are we entering a period of greater price volatility? Is this a plausible long-term scenario?

Inflation volatility increased in the post-pandemic period due to unprecedented shocks. Looking forward it could increase again due to heightened uncertainty. 

Finally, what lessons have we learned from this period of inflationary turbulence? And what tools should be strengthened to better manage such challenges in the future?

As President Lagarde said during her speech at the “ECB and Its Watchers” conference in March, the new environment we are in raises fundamental questions for monetary policy, which are being examined as part of the ongoing strategy assessment. The recent period of inflationary turbulence has underscored the importance of maintaining well-anchored inflation expectations, as they enable central banks to manage inflation with lower economic costs. It has also highlighted the need for a state-dependent reaction function that adapts flexibly to the size, persistence and nature of shocks, particularly in a world with supply shocks and geopolitical uncertainties. To better manage future challenges, policymakers should strengthen tools for scenario analysis, closely monitor inflation expectations and maintain a robust yet agile framework for achieving price stability over the medium term. Ultimately, the commitment to price stability, combined with agility and clarity, will be central to navigating an increasingly volatile global environment.