The overall inflation rate is expected to ease over the next year in spite of recent jumps in prices for energy, food, labor, and imports. The Producer Price Index will rise 2.5%, about half of the 5% rise in the last two years. The Consumer Price Index will also rise about 2.5%, down from over 3% in the last two years. However, expect no price relief for construction materials because of the large share of commodities used in construction that are priced in world markets during a period of very high foreign commodity demand and a shrinking dollar. This includes metals, cement, machinery and plastics and the freight cost to get it here.

Contractors will face high and possibly rising inflation for materials and specialized labor used on the jobsite but lower and falling inflation for off site costs. It will not be easy to explain to facility managers and homeowners why inflation is picking up for you when they see in the news that inflation is generally easing.

Projections of easing inflation are largely based on expectations of declining crude oil prices. Most recent economic forecasts assumed a drop in oil prices from the mid-70’s this past summer to the mid-60’s by next summer, as well as a sharp rise in oil production. There are good reasons for these assumptions, but the reality is that crude prices have soared into the 80’s, approaching $90/bbl. in mid-October. So the assumption of lower energy prices is not a certainty.

Oil prices have jumped $15 in recent weeks because of concern about supplies from Iraq, which Turkey threatens to invade, Iran (which threatens to deny oil to its enemies and is unable to prevent oil production declines), and Russia, which is threatening to use its energy exports as a political weapon.

As a result, speculators have bid up oil prices, hoping to profit from the next piece of bad news from the oil fields. Experience suggests that speculative oil positions will begin to be sold during the winter unless they get the bad news they are waiting for.

A nearly 3% rise in world oil production after several years of little change appears to be a safer bet. OPEC has promised 500,000/bbd and the reserves to deliver on this. Elsewhere, new oil fields are scheduled to start up in the US, Canada, Brazil, Russia, China and Africa. This is the outcome of massive investments begun as long as a decade ago.

Overall, the oil price assumption is a bit shaky but still the most likely outcome.

If energy inflation fails to ebb, the overall inflation rate will be set by trends in wage rates, food prices and the international value of the dollar. Inflation trends have recently picked in each of these areas. Wage and food inflation will likely accelerate in 2008 but dollar devaluation may ease slightly. The exchange rate assumption is also shaky with financial markets still unsteady after the collapse of the subprime mortgage market and the dollar now possibly undervalued after six years of depreciation.

Wage rate changes are now at a 4.1% year/year gain after four and half years of economic growth. Wage gains were 2.5% in 2004-05. Wage gains are rising an even faster 5.0% in nonresidential construction. Food prices are rising at a 4.5% annual pace after a year and half of no change. The main drivers are exports being spurred by a falling dollar and ethanol production now consuming more than 15% of the corn crop. The $US depreciated at a 4% annual pace for five years until this past summer when the rate of decline tripled when foreign investors withdrew from the subprime mortgage and other risky US asset markets.

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