TORONTO, July 30 /CNW/ - 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 labour 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 fuelled 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 fuelled 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 inflation
higher.
    The complete CIBC World Markets report is available at:
http://research.cibcwm.com/economic_public/download/sjul08.pdf.

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