Rising global energy and food prices are fuelling headline U.S. inflation that could hit 4% by next fall, according to a new report from CIBC World Markets.

The report finds that the U.S. Federal Reserve Board, which focuses on core CPI (excluding energy and food prices), will ignore these headline inflationary concerns in the near-term while it focuses on stimulating the economy and keeping it from falling into a recession.

“These secular inflation threats from food and energy will be set aside by the Fed, which will be clearly focused on the cyclical threat to growth from a collapsing housing sector,” says Avery Shenfeld, senior economist with CIBC World Markets and author of the report.

Shenfeld notes that the Fed’s focus on core CPI made sense in a world in which gasoline or food prices went up and then came back down, but that four key longer-term trends are now driving energy and food inflation in the U.S.

First, rapid energy demand in developing nations has stretched supply and pushed crude oil prices to record levels. Second, energy price hikes combined with a weakening greenback are increasing America’s current account and trade imbalance. Third, higher energy costs are being passed on to consumers and businesses through a wide range of core items from airline tickets prices to trucking costs to petrochemical costs for products like plastic. Finally, the policy response to subsidize ethanol production has seen a rising share of U.S. agriculture devoted to growing corn for ethanol production and this has pushed up feed grain prices and in turn meat, dairy and egg prices.

Shenfeld expects the Fed will cut rates in the short-term to kick-start the economy and that improvement will begin in the latter half of next year. This combined with continued pressures on energy and food prices will see headline inflation continue to increase.

“By fall of 2008, an economy that entered a slowdown with a headline inflation rate above 3% could be facing a headline rate taking aim at 4%. As a result, the Fed may be rushing to re-tighten (rates) before year-end 2008.”

The report notes that this approach will see U.S. Treasuries, and by extension, Canadian bonds, feel the heat of rising short rates, and that there will be doubts about the ability of the renewed tightening to quell more ingrained inflation pressures. On a relative basis, this will make inflation-linked bonds a better play.