It is not a coincidence that the end of the world commodity price boom that raised US construction materials costs by 10% from February to July ended when world credit market began to freeze up in August. The credit freeze brought an abrupt slowing in investment, including construction both in the US and in other industrial countries and soured the investment outlook for the next two years. Speculators retreated from the commodity markets, including the metal and oil markets that are the source of a large share of construction materials. Their retreat was hastened by their need to raise cash to cover their bad bets in mortgage bonds.

The international impact is the current falling prices for oil and metals as world economic growth abruptly slows from over 4% to less than 3%. The domestic impact is reduced construction spending in the US that is now trimming prices for domestically priced materials such as lumber, gypsum, cement and labor. Both turnabouts are a significant boost to US construction markets, making the cost of buildings and facilities more competitive with other capacity solutions such as more workers, more software or more equipment. But this is more than offset by the reduced number of construction projects. The Reed Construction Data forecast for construction spending has been measurably reduced. The housing recovery is pushed back as least six months. Nonresidential construction is now declining after a long expansion and will decline well into next year.

The turnabout in inflation means that project cost estimates made earlier this year are now too high. This is the reverse of what happened to project cost estimates made in 2007 that turned out to be too low earlier in 2008.

The restraint on materials cost inflation will persist for at least a year, perhaps into 2010. This is very similar to the long period in 2001-03 when construction materials inflation was negligible fro three years in a depressed economy. During this period of restrained inflation there will be brief price surges for materials priced in auction markets, such as diesel, asphalt, lumber and metals. These are the usual short inventory cycle within longer building cycles. That steel or diesel prices jump 20-30% for a few months does not signal that the period of restrained price inflation is over. That will not happen until economic growth rates are back to the average pace for one of two quarters.

Construction materials price inflation is then likely to be quite high relative to overall inflation that itself will be relatively high. What will cause this? The process of containing and then gradually unraveling the credit freeze involves massive capital injections into the credit markets. Some of these funds are printing press money. When the money supply expands faster than the quantity of goods available to buy, the result in inflation within a few years.

Looking ahead several years, the inflationary drivers will be the excess money supply created in 2008-09, the return to near average economic growth in the US and elsewhere and the still intense investment in developing countries. Another double digit surge in construction materials prices is a few years ahead.