The outlook for construction materials prices this year is more muddled than usual because the economic environment for construction will be in transition.

Overall, prices were steady from May to October, according to the monthly Bureau of Labor Statistics survey, but then jumped an outsized 1.4% in November. Major changes are likely in 2008 for many of the key forces driving materials costs with trend turnabouts expected for some of them during the course of the year.

During 2008, total material demand will turn from decline to increase. Inflation pressures on domestically priced materials will weaken. Inflation pressures on internationally priced materials may ease slightly but will strengthen for some key materials, especially steel. However the long slide in the trade value of the $US will end, easing inflation pressures for imported materials. Also, expect a turnabout during the year with materials demand shifting from decline to increase for materials principally used in residential markets and a significant demand slowdown for materials principally used in nonresidential building.

A little error is the timing and magnitude of any of these turnabouts could translate to a sizable error in the materials cost increase for the full year. Remember 2004 — another year with major trend changes. Materials costs jumped nearly 8% from 2003, well above most forecasts, because the transition to rising demand came sooner and more strongly than generally expected.

Materials cost rose an estimated 5.5% from December 2006 to December 2007 and increased 3.4% for all of 2007 compared to the 2006 average. The most likely outcome in 2008 is for prices to rise slightly less from December 2007 to December 2008 but increase about 4% in 2008 vs. 2007. The year will begin with modest inflation following the price surge at the end of 2007 — which may persist into early 2008 — driven by rising energy costs and the falling value of the $US. Another period of above average price increases is likely at the end of the year. This will be driven by increasing materials demand from contractors.

The key uncertainty for 2008 is how quickly the current crisis in world financial markets will pass. This will determine the timing and magnitude of expected the turnabouts in residential and nonresidential construction starts as well as the value of the $US. The Reed Construction Data materials price forecast assumes that credit markets gradually return to normal operation before summer. Note that normal does not means that bankers chase developers and discount fees to get their loan business as happened in 2005-06, Normal means that loan applicants can reasonably accurately predict how much they can borrow and at what cost and that loan commitments will be kept.

Bankers and other investment managers are now hoarding their cash, content to earn 2-3% in safe investments in Treasury bills rather than risk a loss in higher yielding loans to the construction market. Investors have had to write off AAA rated mortgage backed bonds that proved to be worthless. Quite simply, investors do not trust each other. They have seen many investment funds collapse. Trust is the foundation for this market. The market will be broken until trust is restored.

The FRB and other central banks are taking unusual steps now to value and price mortgage related assets, filling in for the bond rating services that were unable to do this accurately and the bankrupt bond insurance services. If this continues to work as well as it started in mid-December it will make mortgage backed assets tradable again. Banks can sell them, as they intended to do, and use the proceeds for new loans to construction and other industries.

The best way to monitor the progress of this process is to watch short-term Treasury bills rates and construction starts of commercial projects. 90-Day Treasury bill rates plunged from 5% to 3% shunned new loans and began to hoard cash. Movement toward normal, now probably 4.5%, will signal that the flow of loans is improving. You can check yields daily here.

The most timely reports on construction starts trends, in the second week after the end of the month, can be found here.

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