The Peril of Services Inflation: Western Convergence, Labor Shortages in Hospitality, and What’s Slowing the CNB’s Rate Cuts

Tomáš Adam, Jiří Schwarz (Originally published in Hospodářské noviny, April 29, 2025, Commentary Section)

A paradox confronts most European economies today: while headline inflation has hovered near the ideal 2% mark for over a year, many Europeans still shake their heads in disbelief at the prices of lunch, vacations, or a trip to the hairdresser. One reason is that service prices are significantly higher than we were used to. In the Czech Republic, they are still growing at nearly twice the pre-pandemic pace. According to the HICP index constructed by Eurostat, the cost of services in March was 4.9% higher than a year earlier.

Recent data show clear improvement. In June of last year, service prices were increasing at a year-on-year rate of 6.5%, which has since dropped by 1.5 percentage points. However, part of this decline is a “tax illusion.” Changes in VAT last year temporarily boosted the index by about one percentage point. Once these effects dropped out of the comparison base this year, it created the appearance of lower service inflation.

But this influence can be filtered out—something the Czech National Bank (CNB) does when reporting core inflation. One approach is to focus not on year-on-year changes but on so-called inflation momentum—three-month averages of seasonally adjusted month-on-month changes, which are much quicker to shake off one-off effects such as tax shifts. And these momentum indicators confirm that service price growth steadily slowed throughout 2024 and has decelerated even more in early 2025. Still, price growth remains close to 2019 levels, when the economy was already showing signs of overheating.

Why, then, does service inflation remain so high despite the CNB’s sustained restrictive monetary policy? We identify three key reasons.

First, service prices generally show higher inertia—price shocks take longer to pass through. This is partly due to inflation clauses in rents and housing-related services like building maintenance or inspection services. Similarly, rising insurance premiums in response to higher insured values feed into broader service costs, including haircuts and restaurant meals. Energy prices also transmit into service pricing, though with a delay.

Second, the structure of the Czech economy is changing. The share of services in household consumption is rising, aligning with Western norms where, for instance, eating out every day is not the standard. Consumption patterns are shifting from quantity to quality, which comes with higher prices. Demand is also increasing—tourism has finally surpassed pre-COVID levels.

Third, labor shortages persist in hospitality and accommodation. Employment in these sectors remains 6% below pre-pandemic levels. Businesses must offer higher wages to attract staff. So far, a recovering appetite for consumption among Czechs and the return of foreign tourists allow firms to pass on these higher wage costs to consumers.

What does this mean for the CNB? Central bankers will remain cautious with rate cuts—not only because of labor market tightness and fast-growing wages, but also because inflation’s composition is far from ideal. To maintain inflation near the 2% target, there’s little room for another round of food price hikes or a rebound in energy prices, which are currently declining. The recent turmoil in global trade could further push up goods prices, which have so far remained subdued. In the past, globalization helped hold goods prices down, contributing significantly to price stability.

Monetary policy’s task remains clear: it must prevent “stubborn” service prices from anchoring inflation at a level above what is acceptable for the central bank. Although the pace of service price growth is slowing and wage growth may moderate as the labor market loosens, the battle is not over. Even though monetary policy is forward-looking, it cannot rely on service price inertia dissipating quickly on its own.