"Core inflation is dead. It won't be long before the Fed and the bond market both have to pay much more attention to headline rather than core prices," wrote CIBC economists Avery Shenfeld and Meny Grauman in new report from CIBC.

The two economists are hardly alone. On BNN, Dick Bove, an analyst with investment and brokerage firm Ladenburg Thalmann, told BNN he no longer believes inflation can be contained and that the current methods of calculating CPI in the U.S. had fallen sway to politics, as successive presidents took heat for rising fuel costs and their impact on inflation.

"Today, calculating the CPI as it is done now, is at 3.9% but if it's done as it was in Ronald Regan's time, it would be up 11%," Bove said.

Bill Gross, managing director of Pacific Investment Management Co., also recently questioned the methodology of U.S. CPI calculations in his blog, arguing that adjustments to the way inflation is calculated don't give Americans an accurate picture of their economy.

"In the 1990s the U.S. CPI was subjected to three additional changes that have not been adopted to the same degree (or at all) by other countries, each of which resulted in downward adjustments to our annual inflation rate," Gross wrote.

"Product substitution and geometric weighting both presumed that more expensive goods and services would be used less and substituted with their less costly alternatives: more hamburger/less filet mignon when beef prices were rising, for example. In turn, hedonic quality adjustments accelerated in the late 1990s paving the way for huge price declines in the cost of computers and other durables. As your new model MAC or PC was going up in price by a hundred bucks or so, it was actually going down according to CPI calculations because it was twice as powerful. Hmmmmm? Bet your wallet didn't really feel as good as the BLS did."

In their article, Shenfeld and Grauman don't take issue with the way the U.S. calculates CPI, but they do argue that food and energy costs are not being offset by disinflation in the core CPI basket.

While Bove told BNN an explosion of money supply is driving up inflation globally, Shenfeld and Grauman write that fundamental shifts in the world economy are driving up prices for food and fuel as developing nations shift to more protein-intensive diets and rising standards of living are putting more cars on the road.

"In the U.S., inflation has been low only for those prepared to ignore what is staring them in the face-sharply rising energy and food costs. Of course, the convenient 'core' CPI index does just that, but the rationale for focusing on core price measures no longer exists," the CIBC economists wrote.

"Food and energy prices are not seeing short-term volatility anymore. They are simply trending consistently higher."

U.S. home prices are dropping, but Grauman and Shenfeld argue that the precipitous drop is should do little to moderate CPI and they say history shows U.S. recessions have little impact on headline inflation.

"The CPI's failure to come back to earth - still running in the 4% range next year-will be a big disappointment for both policy makers and the bond market, both of which are currently counting on recession to wipe inflation off the map. Instead, the Federal Reserve is going to have to lean in with rate hikes and constrain the pace of 2009's economic rebound as it begins to get more worried about headline inflation," Shenfeld and Grauman said.

Canada won't be able to hide from inflation either, they added. While Canada has been able to escape much of the inflationary trend gripping the world thanks to the appreciation of its currency, a 1% cut in the GST and a price war between supermarket chains, that shelter is coming to an end. The price war seems to be finished and the loonie won't see the same lift in the year ahead.

"Our above-consensus forecast for the loonie calls for only modest year-on-year currency appreciation over the next 12-months and should therefore only have a very small moderating influence on inflation. As a result, Canadian CPI should accelerate over the next six quarters, reaching 3½% year-over-year by the end of 2009, and catching the eye of a central bank that aims to keep this measure at 2%," they wrote.

That will mean a 100 basis point boost to administered rates in 2009, they said, sending 10-year Canada yields sharply higher.

"Government bonds, which seemed like the safe place to be earlier in 2008 when credit markets crashed, will be anything but safe in the year ahead. At the same time, stocks whose bottom lines benefit from rising commodity prices will outperform those sectors that traditionally get hit by rising rates like banks, REITs and utilities," the economists said.

Grauman and Shenfeld are forecasting a commodities-linked spike in inflation in Canada in 2009 after a near-recession in 2008. In the U.S. they predict U.S. inflation will remain at roughly 4% year-over-year despite a recession.

"Although the Fed has signaled a pause in its current easing campaign, we see another quarter-point cut in the cards before policymakers start ratcheting up rates towards the end of the year," they concluded.

By Sean McKibbon, This email address is being protected from spam bots, you need Javascript enabled to view it , edited by Nancy Girgis, This email address is being protected from spam bots, you need Javascript enabled to view it