Expect inflation, oil to rise in wake of bailout: Rubin

The proposed $700 billion rescue of Wall Street by the U.S. government will help avert a meltdown in the world’s financial system but will ultimately lead to higher inflation and higher interest rates, according to a new economic forecast from CIBC World Markets.

“While the cost of taking another path will never be known, the cost of the one chosen is clear enough,” says Jeff Rubin, chief economist and chief strategist at CIBC World Markets. “Higher deficits can only bring higher taxes, and higher inflation can only bring higher interest rates. Both are on their way in the American economy.”

While this is generally a bad-news scenario for Americans, it may be an upside development for Canada’s resource-rich economy, Rubin told attendees at the CIBC World Markets Eastern Institutional Investors Conference in Montreal.

“With fears of a financial system meltdown and growth collapse averted, prices for a range of commodities have already likely seen their lows,” Rubin says.

He expects global growth to settle at a respectable 3.8% this year and 4.2% in 2009. That pace should quickly push up prices of commodities, including oil, which he expects will average at a record-high $150 per barrel over the second half of 2009 as the economic recovery jump-starts demand.

“For the commodity- and particularly energy-leveraged Canadian economy, the U.S. Treasury bailout is unambiguously good news. After all, it won’t be Canadian taxpayers that are on the hook, while it will be Canadian resource and energy companies that will benefit from the stability brought to financial markets and the more bullish outlook that shines on world growth,” he says.

The stark jump in commodity prices will push the U.S. Consumer Price Index through 6% in the latter half of 2009. Rubin notes that the last time CPI inflation was that high was in 1990, when the federal funds rate was 7.5%, or four times what it is today.

Rubin expects the U.S. Federal Reserve to begin raising interest rates by the second quarter of next year.

“Once started, however, they have a long way to go. By year-end, they will have hiked the funds rate by 200 basis points in what is likely to be a protracted and painful adjustment in real interest rates,” he says.

In Canada, Rubin expects the markets to take off until the Bank of Canada has to follow suit on raising rates.

“The TSX is likely to take a run up to 14,000 before feeling the bite of interest rate hikes later next year. Not having cut rates as much as the Federal Reserve Board, the Bank of Canada will find itself in the enviable position of not having to raise them as much on the way up. The Bank is likely to do no more than half the Fed’s 200-point rise, while the loonie breaks through parity again on the back of climbing crude prices,” he says.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com