Services vs goods inflation: why they diverge — and why it matters for policy

Services inflation is primarily driven by wages, because services businesses are labour-intensive. Once wages rise — as they did sharply in 2022–24 — they rarely fall. This is wage stickiness. Service businesses maintain higher prices to cover their higher wage bills. Even as the original cost-of-living shock fades, the wage increases it triggered stay in the system. This is the mechanism behind inflation persistence and the wage-price spiral risk.

The largest components of services CPI are: housing/rentals (the biggest single weight in most baskets), restaurants and hotels, recreation and culture, education, healthcare, and financial services. In the US, shelter alone is around 35% of total CPI — which is why US shelter inflation has been so influential in keeping headline CPI elevated.

In theory yes, but only to a limited degree. With services at roughly 60% of the basket and goods at 25%, goods would need to be in severe deflation (−3% to −4%) to arithmetically offset 5.5%+ services inflation. That degree of goods deflation would signal serious demand weakness or a deflationary spiral. Central banks prefer to wait for services to fall organically rather than rely on goods deflation to pull down the average.