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Construction’s inflationary cycle turned the corner during 2006 and will continue heading downhill through 2007 and 2008, according to industry forecasts. ENR predicts that annual inflation measured by its cost indexes will decline as prices for most construction materials start to subside, after absorbing wave after wave of double-digit increases since 2004. But as the inflationary cycle moves into a new phase, it is shifting gears. Estimators say inflation is still sneaking into their bids as the large volume of work in the nonresidential building and civil works markets reduces competition and aggravates labor shortages.

Weaker material prices in 2007 will have the biggest impact on ENR’s Building Cost Index, which is forecasted to increase just 0.7% next year. Inflation measured by this index already had been easing, slipping to 2.6% this year after increasing 5.0% in 2005 and 9.7% in 2004.

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ENR’s Construction Cost index, which is more heavily weighted toward labor costs, is predicted to increase 2.7% next year, after increasing 3.2% this year, 4.6% in 2005 and 7.8% in 2004.

The most critical element in forecasting ENR’s indexes is labor costs, which account for 79% of the CCI and 63% of the BCI. A year ago, ENR’s forecast called for a 4.4% increase in the indexes labor component. The actual increase was 3.6% for the skilled labor component of the BCI and 3.8% for the laborer component of the CCI.

ENR is forecasting that the labor component of its indexes will hold close to the increases already negotiated for next year. Multiyear collective bargaining agreements reported by the Construction Labor Research Council, Washington, D.C., call for another 4.7% increase in 2007. ENR expects the labor component of the BCI to match this increase. The CCI’s labor component is forecasted to increase 5.0% next year as ENR’s wages for laborers catch up to the 5.0% national average increase reported this year by CLRC.

“The driver for inflation is different from what it was two years ago,” says Karl Almstead, vice president for the Turner Construction Co., New York City. “The uncertainty that we saw in the materials market is being carried over into labor. The availability of skilled labor is causing productivity issues, which increases the cost of labor beyond that measured in labor settlements,” he says.

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Wave Subsiding

This year’s double-digit price hikes for copper, steel and asphalt may have been  inflation’s last hurrah on the materials front. “The commodity cycle [that has been driving inflation] is coming to an end,” says Michele Halickman, the construction materials analyst for the Washington, D.C.-based forecasting firm Global Insight Inc.

Some of the pricing turnarounds predicted by Global Insight are dramatic. Prices for light structural steel will fall 11.4% next year after climbing nearly 15% in 2006. Likewise, wallboard prices will fall 8.9%, following this year’s 18.8% increase. Prices for paving asphalt are expected to increase just 9.4%, after jumping 27.7% in 2006, Halickman says.

The slowdown in materials price escalation will have a major drag on ENR’s cost indexes in 2007. Weaker steel, cement and lumber prices are expected to pull down the materials component of the indexes by 6.3% by next December.

The biggest reversal will be for steel prices, which account for 22% of the BCI. ENR’s forecast calls for the steel component of the indexes to decline 8.7% next year, following increases of 9.6% in 2006, 12.6% in 2005 and 31.3% in 2004.

Steel imports in 2006 were almost as high as they were during the Asian financial crisis of 1998 but most of the import activity has been for sheet, says John Anton, Global Insight’s steel analyst. Imports for structural failed to materialize due to strong demand in the world markets for those products, he adds. “That is why structural prices were so darn high this year,” says Anton.

Structural prices ended the fourth quarter of this year at $643 per ton, a 12.1% increase over the fourth quarter of last year. Anton believes that will change in 2007 and predicts imports will finally start to respond to high domestic prices, helping to push the average price for structural steel down 18% by the end of next year.

Lumber is the next-largest materials component of ENR’s indexes, accounting for 13% of the BCI. The slowdown in housing starts already has cut into lumber prices this year and those declines are expected to continue through most of 2007, says Paul Jannke, vice president of wood products for the forecasting firm Resource Information Systems Inc., Bedford, Mass.

RISI predicts that by next December, the average price for 2x4 western spruce will decline another 8.3% to $244 per thousand board ft, following this year’s decline of 20.8%. Prices are being squeezed by a combination of falling demand and excess capacity, says Jannke. But he says mills are losing money at current prices and he expects closures will help drive up prices by the end of 2007. Jannke says RISI is tracking the same trends for OSB and plywood prices.

Portland cement is the third materials component of ENR’s indexes and cement prices have been increasing at a 12.4% annual rate for the past two years, says Halickman. A surge in imports from China and a new trade deal with Mexico have eliminated the chronic cement shortages of a few years ago. This, coupled with weaker demand from the housing market, will stall further price hikes. Global Insight predicts cement prices will start to fall during the second half of next year, ending 2007 with a 1.2% gain. ENR is forecasting a 3.3% increase in its price.