Third District business conditions were mixed in February. Manufacturing activity was declining. Retail sales were rising amid widespread markdowns to reduce inventories. Auto sales were steady, but off from February of last year. Bank loan volumes outstanding have been decreasing as consumer and residential real estate lending have moved down. Construction contracting continued to slip, but commercial real estate markets were firm and home sales were steady.
The outlook among the business firms contacted for this report is that overall economic activity will gradually improve in the second half of the year. Manufacturers expect an upturn by the middle of the year and modest growth thereafter. Retailers forecast a further increase in the pace of sales as the spring selling season gets under way. Auto dealers expect the sales rate to be steady for most of the year, but below last year's rate. Bankers foresee no growth in lending until business conditions improve later in the year. Real estate markets are expected to remain firm, although construction is forecasted to ease further.
Third District manufacturers reported that falling demand for their products had continued into February from January. New orders and shipments declined for the second month in a row. Order backlogs decreased as well. The decline in business has affected almost all of the major goods-producing industries in the region. Makers of capital equipment have experienced serious declines in demand, although some manufacturers of lumber products and industrial equipment posted gains in orders. Food processing companies also reported some improvement. The high value of the dollar in relation to foreign currencies continues to be mentioned by Third District manufacturers as a constraint on their ability to counter foreign competition or expand exports. The high dollar has also prompted some firms to shift production overseas.
Manufacturers expect only very slight improvement in business conditions during the next six months. Several indicated that they expect any upturn that takes hold to be only modest. On balance, the region's manufacturers have trimmed capital spending plans for the first half of the year. Some producers of industrial and business equipment reported that their customers were also canceling or indefinitely deferring expansion plans originally scheduled for this year.
Retail sales in the Third District were steady in February and slightly above the year-ago rate. In general, retailers said consumer confidence appears to be holding up, although some merchants noted that consumers seem to be reining in impulse buying and nonessential purchases. Large general merchandise and specialty stores that were offering lower prices appeared to be achieving somewhat better sales than small stores. Stores have cleared out most of their inventories of winter goods by extensive discounting. Merchants expect sales to be seasonally slow in early March and pick up later in the month. Some store executives said that spring merchandise that was available in late February was selling well.
Auto dealers generally indicated that sales picked up a bit in January compared to December, but were just steady during February, and below the rate posted in February of last year. Inventories were above desired levels, and dealers were looking to continued manufacturers' incentives to reduce the oversupply. Looking ahead, dealers expect generally steady sales, but at a rate significantly below that of the past few years.
Total loan volume outstanding at Third District banks has slipped since the beginning of the year as a result of declines in consumer and residential real estate lending. Bankers believe households are attempting to reduce indebtedness in response to uncertainty about economic conditions and recent erosion in their personal financial positions. Business lending has been virtually flat. Bankers contacted in late February said firms are limiting their borrowing as they reduce operating rates and scale back
expansion plans in response to slackening demand for their goods and services. Some bankers said that among their business customers, manufacturers were experiencing decreasing liquidity as their inventories have increased and their accounts receivable have been taking longer to collect.
Bankers in the Third District expect overall loan volumes to be flat or to increase slightly this year. Bankers generally believe the regional economy will be nearly flat in the first half of the year, followed by modest growth beginning in the third or fourth quarter. They do not expect demand for loans to increase until the improvement in business conditions is well established.
Real Estate and Construction
Commercial real estate markets remain firm in most parts of the Third District. The vacancy rate for office buildings has been steady in the Philadelphia central business district and in suburban markets. Average rental rates have increased by small amounts since the fall, although rates for higher quality offices have increased more significantly. Some space has become available for sublet as a result of cutbacks in planned expansion by firms, especially those involved in Internet businesses, but the supply has not significantly affected market conditions. Demand for space for biotechnology facilities continues to be strong. Contacts in commercial real estate markets expect nearly steady vacancy rates and rents this year, although some anticipate that effective rents will ease as building owners provide more generous allowances for tenant improvements. Looking ahead, contacts in the commercial real estate industry expect construction activity this year to fall below last year's rate.
Residential real estate agents generally indicated that sales of existing homes have been steady so far this year. Homebuilders also reported that sales during January and February were steady, but down from the pace set last fall. Some real estate agents and builders noted that sales of higher priced homes have increased recently, and they attribute this to a decline in mortgage interest rates. House price appreciation has been steady for both new and existing homes. Builders indicated that the availability of labor and materials has improved compared with last year but that land has become less available and more expensive.