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Federal Reserve Districts

First District--Boston

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Business contacts report continued growth in the New England economy, although some sectors are lagging the overall pace. Retailers cite healthy increases in sales, while manufacturers and software and information technology (IT) services firms indicate that results range from "okay" to robust. Staffing firms also report increasing demand, but some say the pace is slower than last quarter. While comments about rising prices are less at the forefront than in the last report, high input costs remain a concern. Commercial real estate markets in the region remain sluggish.

All First District retail contacts report strong increases in April same-store sales from a year earlier, ranging from 4 to 9 percent. However, most indicate dismal New England weather damped May's results. Sales of lumber and hardware remain particularly strong as the housing boom continues. Flat-screen televisions, digital cameras, wireless networking and other higher-end goods are said to be selling well. By contrast, top-of-the-line clothes are not.

Inventory levels are up slightly according to most contacts, but are in line with sales. Multiple respondents report rising vendor prices for petroleum and steel-related products; lumber and television prices are falling and appliance prices are increasing. Most vendor price changes are being passed on to consumers, although selling prices for clothing have continued to fall due to competitive pressures. Gross margins are slightly up for most contacts. Wage growth and employment are mostly stable, although some retail contacts report increased headcount due to acquisitions, new stores, or increased sales. Most contacts are increasing capital spending in order to upgrade distribution methods or outdated information technology equipment, and they have the cash on hand to do so. Those who aren't currently upgrading their equipment did so recently.

Retail respondents are now more optimistic about their business than they were last quarter, and they all expect sales in coming months to be as strong as their April numbers, if the weather is decent. The one serious source of concern for several contacts is rising health insurance costs.

Manufacturing and Related Services
First District contacts in manufacturing and related services report mixed sales and orders through the second quarter of 2005. Demand for aircraft-related and computing equipment is said to be strong and rising. Sales of some other capital goods and semiconductor sales are reportedly improving as well. However, many manufacturers describe business as merely "okay," if not "disappointing." A couple of firms cite transitory factors such as poor spring weather or the early Easter. Others note weakening demand for cargo containers or transportation services, or softening demand from the Big Three automakers. A common refrain from contacts is that their firm "has the volume, but not the margins"--which they tend to attribute to either low-cost competition from Asia or high input prices.

On the whole, manufacturers remain quite concerned about the high costs of raw materials, energy, and transport. Various respondents indicate that although they no longer face escalating costs for metals or petroleum products, they need to increase their selling prices further to restore margins to acceptable levels. Manufacturing contacts express doubts that large retail chains and other business customers would accept price increases, or that their competitors would follow suit. Only those firms producing unique or technologically advanced products seem largely unconcerned about margin pressures.

Companies continue to explore outsourcing and other methods to reduce production-worker and back-office employment. Pay for these types of jobs is said to be rising at a rate of 2.5 percent to 3 percent. Markets for professional, technical, and managerial employees are said to have tightened, resulting in salary increases of 3.5 percent to 4 percent and some delays in filling positions.

Manufacturers tend to be holding their capital spending constant or increasing it slightly. They are investing in new capacity overseas while concentrating mostly on improving efficiency and automation or developing new products at domestic facilities.

Respondents are mostly guardedly optimistic about their business through the end of 2005, although several note the adverse effects of high input costs on their profitability. Compared to past conversations, manufacturers express greater concern or uncertainty about longer-term strategies.

Temporary Employment Firms
Demand for temporaries continues to grow, but some companies report that the rate of growth seems to be slowing. This pause seems most pronounced for manufacturing and light industrial positions. By contrast, demand is said to be strong for technical and IT-related workers, as well as for engineering, financial, healthcare, administrative, and government-related employment. Permanent hiring continues to grow at a strong pace, and the available supply of labor continues to decrease, albeit gradually.

Prices are steady or rising slightly. Unemployment insurance costs are increasingly worrisome, and health insurance continues to be a concern. Worker's compensation insurance costs are flat or slightly down in the past few months. While more hesitant to give concrete predictions of future performance than they were three months ago, staffing respondents are fairly confident about the recovery, and believe 2005 will be a better year than 2004.

Commercial Real Estate
Commercial real estate markets in New England continue to struggle. Despite some increase in employment, most office markets in the region have not experienced any substantial improvement during the past quarter. Large firms have not hired enough people to make a difference in overall demand for space. In addition, consolidations and acquisitions by out-of-state companies have increased vacancy rates in some areas. In the Boston market, office vacancy rates remain in the mid-teens in the city and exceed 20 percent in the suburbs. Contacts do not expect office rental market conditions to improve noticeably until the region's job growth picks up its pace.

At the same time, office buildings in Boston continue to sell at what contacts call "exorbitant" prices. One respondent expressed concern that high building prices raise the probability of new construction of office buildings, which would further raise vacancy rates.

Software and Information Technology Services
Contacts in the software and IT services industries report year-over-year quarterly revenue increases ranging from near zero to 13 percent in their most recent quarters, with half the contacts close to the high end of the range. A couple of respondents mentioned particularly strong demand growth from customers in the financial services industry.

Over half of contacted firms are increasing their headcounts, generally modestly, via selective hiring of technology workers and marketing/sales personnel. One software firm is focusing its additional hiring in India; another is recruiting aggressively in Massachusetts. Most respondents report that wage increases are moderate, notwithstanding some perceived tightening in technology labor markets.

Software and IT services contacts indicate they are holding capital spending fairly level. One respondent explained that they are increasing the number of computers and servers in proportion to increases in personnel, but declining computer prices allow them to do so without raising spending.

The outlook among software and IT services contacts is cautiously positive, with most expecting a continuation of their current pace of growth. The economy is viewed as somewhat uncertain; it is said to be currently steady--not robust, not deteriorating--but with more downside than upside risks.

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Last update: June 15, 2005