U.S. headline inflation to hit 6 per cent in 2009: CIBC World Markets

Jul 30, 2008, 01:00 ET from CIBC World Markets

    NEW YORK, July 30 /PRNewswire-FirstCall/ - CIBC (CM: TSX; NYSE) -
 Headline CPI inflation in the U.S. will hit six per cent within the next
 six months forcing the Federal Reserve Board to raise interest rates by at
 least 200 basis points, forecasts a new CIBC World Markets report.
     The report notes that the American economy has not seen an inflation
 rate this high since 1990 - and that only lasted four months. "You've got
 to go back to 1982, in the midst of the stagflation that followed the
 second OPEC oil shock, to see the last time American inflation was clocked
 at that kind of pace for any sustained period," says Jeff Rubin, chief
 economist at CIBC World Markets.
     Mr. Rubin notes that soaring energy prices are once again driving
 inflation concerns but that today high prices are emboldening the
 bargaining positions of many U.S. workers. "Soaring energy costs are
 rapidly turning global cost curves on their head. As shipping costs soar
 with triple digit oil prices, the once omnipotent threat of Chinese
 competition is growing fainter every day. And the same energy costs that
 now protect American workers with soaring freight costs are at the same
 time eating away at their pay checks at the gas pumps."
     The result of these factors is the likely return of cost of living
 allowances (COLA) in North American wage negotiations, particularly in
 highly organized industries like steel, where soaring freight rates are the
 equivalent of double digit tariff protection. He notes that high energy
 prices give American manufacturing workers bargaining power that they have
 lacked for over a decade while at the same time encouraging them to ask for
 larger pay raises to keep pace with the soaring price of gasoline.
     "Back in the 1980s, most collective bargaining agreements of the day
 had cost of living allowances built into the wage scale," says Mr. Rubin.
 "Those COLA clauses largely became self-fulfilling prophesies by ensuring
 that largely oil price driven inflation would become self-sustaining
 through a wage-price spiral."
     With changing labor rates building in inflation clauses, Mr. Rubin
 expects that interest rates will also have to rise. The report notes that
 when inflation rates touched six per cent in 1990, the Federal Reserve
 funds rate was running around seven and a half per cent, over three times
 what it is today. At the same time, a 10-year Treasury Bond was yielding
 8.5 per cent, over double what it yields today.
     "We expect that the Federal Reserve Board will raise interest rates no
 less than 200 basis points by the end of next year," adds Mr. Rubin.
 "History says we will be very lucky if they don't have to do more."
     The report finds that despite the recent decrease in global oil prices,
 supply pressures will continue to drive crude costs up which will translate
 into higher consumer prices at the pump, at the grocery store and at the
 electricity meter.
     Mr. Rubin notes that an exploding thirst for oil and waning production
 in the Middle East saw crude exports from the region drop by over 700,000
 barrels a day in 2007. While producers in the region claim they will be
 able to boost exports, the bank's research points to a further decline in
 exports of one million barrels per day in the next four years.
     "If world oil markets are to see new supply over the next four and a
 half years, it won't be coming from OPEC," says Mr. Rubin. "While exports
 fell in 2007, daily oil consumption in the Middle East itself climbed by
 some 300,000 barrels (per day). The increase matched the increase recorded
 by China, a country with quadruple its population."
     The report notes that oil consumption has not only been driven by huge
 energy subsidies at the gas pumps that see motorists paying a tenth or so
 of the prevailing global rate but by a rapidly growing demand for
 electricity that is fueled by "even more egregious subsidies for oil and
 gas-fired electricity". Subsidies across the region see power consumers
 paying anywhere from a half to just a 14th of what a typical North American
 household is charged.
     Since the region has no coal or nuclear electricity plants, and has
 very limited hydro capacity, the region relies on plants fueled by fossil
 fuels. With some of the world's fastest growing populations, electricity
 consumption in the region has increased by more than six per cent annually
 since 2002 and now consumes some 320,000 barrels of oil per day. With Saudi
 Arabia looking to triple its electricity capacity by 2020 and other
 jurisdictions like Dubai - which has the highest electricity demand growth
 in the region at 15 per cent annually - switching from scarce natural gas
 to oil, electricity consumption will continue to climb at two to three
 times the rate in the OECD.
     A growing population and a growing economy have also intensified the
 region's need for fresh water - something in increasingly short supply.
 Natural water production in Saudi Arabia is already down 50 per cent from
 its mid-1990s peak. Current water use in the country is seven times the
 sustainable level with consumption levels in the United Arab Emirates and
 Kuwait running at 15 and 22 times the level of natural replacement.
     This is driving an urgent need for more hugely energy-intensive
 desalinization plants. According to the World Bank, over the next 10 to 15
 years, the Middle East will need an extra 50-60 billion cubic feet of water
 annually. Desalinating that immense volume could ultimately require one
 million barrels of oil per day or its energy equivalent in natural gas.
     Mr. Rubin says that despite OPEC's recent claim that it has no
 responsibility for triple digit oil prices, his research found that the
 cartel's practice of highly subsidized oil consumption will continue to
 reduce exports from the region. That in turn will drive both oil prices and
 U.S. inflation higher.
     The complete CIBC World Markets report is available at:
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SOURCE CIBC World Markets