Services Inflation, A Global Phenomenon with Persistent Risks
Inflation in services has become a defining feature of the current economic landscape, diverging sharply from trends in goods, food, and energy prices. This is a partial translation of the analysis we conducted on the minutes cited for the Monetary Policy Report of the CBCH, Jun 2024
Context:
The Recent evolution of Global Service inflation
Services inflation has remained stubbornly high across developed and emerging economies, contributing around one percentage point to total inflation above pre-pandemic levels. Annual global inflation contributes over 80%, while the other 20% is the sum of the remaining elements. This unusual global synchrony highlights unique factors driving services inflation and points to a slower path toward normalization.
The Unusual Synchronization of Services Inflation
Historically, service inflation has been closely tied to domestic economic cycles. However, since the pandemic, a more global pattern has emerged. Estimates using dynamic factor models reveal that the global factor driving services inflation accounted for about 50% of its variance post-pandemic—up from just 15% during 2015-2019.
Drivers
This synchronization among global inflation can be attributed to:
- Pandemic-Related Shocks: Global lockdowns and supply chain disruptions created synchronized demand movement through restrictions on movement and trade.
- Geopolitical Crises: The war in Ukraine compounded these effects by disrupting global trade and pushing up transportation and raw materials costs.
- Policy Responses: Monetary and fiscal measures taken worldwide to address these shocks also played a role in aligning inflation dynamics. These policies acted simultaneously worldwide.
- The rebalancing of relative prices between goods and services: Following the pandemic, service prices fell behind the general price level as goods inflation surged. Much of the recent increase in services inflation has been driven by a correction in these relative prices. However, the process is essentially complete, with limited scope for further rebalancing to contribute to inflation normalization.
Risks of Persistent Services Inflation
Evidence suggests that service inflation tends to be more persistent during periods of high overall inflation due to indexation mechanisms. For instance, in the US, services inflation persistence doubled during the inflationary spike of 2021-2022. While persistence has eased recently, it remains elevated compared to pre-pandemic levels, posing a risk of delayed normalization.
Furthermore, country-specific factors also contribute to the dynamics of services inflation, including Monetary and fiscal policies, migration trends, changes in productivity and investor sentiment, and geopolitical developments affecting global goods prices.
What Lies Ahead?
The path to normalizing services inflation will likely extend over the next few quarters. Several factors could slow this process, such as intensified indexation mechanisms during the inflationary spike, resilient consumer demand in key markets like the US, and Country-specific dynamics affecting relative price adjustments. While total inflation may continue to ease, services inflation remains a wildcard that could delay full convergence to pre-pandemic levels, especially in economies with resilient demand and policy-driven price adjustments.