Metals demand may ease as inflation gains: Barclays

NEW YORK (Reuters) - Increased global inflation and rising interest rates will crimp demand for base metals by the year end, but supply constraints, strong emerging market demand and high production costs will keep metal price floors at higher levels than ever before, Barclays Capital said on Thursday.

"We see global tightening in monetary policy. To the extent higher interest rates slow global industrial demand, you will see some pressure on base metals prices overall," said Head of Research Larry Kantor on Thursday at the investment bank's quarterly briefing on financial markets.

But, Kevin Norrish, commodities research director added that a dramatic escalation in production costs seen across all metal markets, including steel, would limit any declines, with strong fundamentals in aluminum and copper markets suggesting further price increases longer term.

"Even if we were to see a sharp slowdown in demand, we think price supports would come in at much higher levels than it has in the past, as a result of those higher cost floors."

Norrish noted that the supply side for metals continues to deteriorate, while demand has remained strong.

"The supply side has been hit by power shortages, strikes, declining ore grades, lots of different factors at work here. So we think the supply side, particularly in copper and aluminum, stays very tight. And we think there is considerable upside price potential in those markets going forward."

He added that further production losses look likely for copper and aluminum, as those problems persist, giving those metals the best upside price potential.

The "disappointing" response to supply problems has been combined with strong demand from emerging market economies.

Metals demand has been growing at a slower rate partly because of global interest rate tightening, Norrish said, but it remains robust. And with consumer inventories at relatively low levels in the U.S. and China, there is potential for it to accelerate in the second half.

"It's global industrial demand that matters and China is the key area where the growth is coming through now," he said.

Some sectors of Chinese metal demand has slowed, but the big driver has been infrastructure spending.

"We don't think that is terribly sensitive to changing interest rates. So the outlook in Chinese demand growth, which is the key driver for base metals, still looks pretty healthy overall," said Norrish.

Kantor added that Barclay's sees fundamental supply and demand as the cause for commodity price increases.

"The megatrends we've seen in commodities over the last few years will remain very firmly in place as far as fundamentals are concerned," Norrish said.

As a result, Kantor said Barclays research team raised its global inflation outlook by more than a percentage point to 5.0 percent for 2008 and by 0.7 percent to 3.7 percent in 2009.

"This is a big deal. It's pervasive. It's across the board and it's important," he said of the revised inflation outlook.

He added that analysts tend to discount the importance of the recent rise in commodity prices and the resulting inflation surge, pointing out that the rise in raw material costs from energy, grains and oil seeds, and base metals alone over the past 12 months has amounted to about 5 percent of global GDP.

"Our view is that high commodity prices are here to stay."

(Reporting by Carole Vaporean; Editing by Marguerita Choy)