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Federal Reserve Districts

Twelfth District--San Francisco

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The Twelfth District's solid economic expansion remained on track during the survey period of early June through mid-July. Price inflation for final goods and services moderated somewhat. Labor markets tightened further and an increasing number of employers relied on incentive compensation to meet recruiting challenges. District retailers and service providers reported sales gains, and growth in manufacturing activity picked up following a slight lull during the previous survey period. Demand rose further for District agricultural and resource-related products. The pace of home sales and price appreciation remained rapid but slowed slightly in some markets, while demand for commercial real estate continued to improve. District banks reported strong loan demand and good credit quality.

Wages and Prices
Contacts reported modest inflationary pressure on net in recent weeks. Energy costs rose significantly, increasing prices of production inputs for which energy costs are a significant component, such as transportation services, fertilizers, and some construction materials. However, contacts in most sectors noted that pricing power for final goods and services remained muted more generally, citing vigorous competition from domestic and foreign producers and continued gains in production efficiency as restraining factors.

Demand for labor increased, and District labor markets tightened further. The most significant recruiting and retention challenges were reported for skilled occupations in the financial, construction, information technology, and health-care services sectors. Contacts in the agricultural, retail, services, and financial sectors reported substantial reliance on temporary workers to meet demand. Although wage growth generally remained in the modest range of 2 to 4 percent, contacts in several areas reported rising use of incentive compensation, including signing bonuses to attract qualified workers. Employer costs for health insurance benefits remained on a relatively steep upward trajectory, causing total compensation to rise more rapidly than wages and salaries. Looking ahead, about one-third of respondents plan to increase their pace of hiring for permanent staff during the second half of 2005 compared with the first half, and virtually none plan to reduce their pace of hiring.

Retail Trade and Services
District retail sales expanded during the survey period. Automobile sales climbed substantially, as demand remained strong for imported makes and purchases of domestic makes surged in response to price discounts by manufacturers. Sales of apparel and other small retail items also rose, and prices for these items generally were flat or fell because of extensive discounting.

District service providers reported a substantial increase in demand on net. Sales were robust for providers of food, transportation, and health-care services. Contacts reported continued strong growth in tourist visits to key destination states such as Hawaii, California, and Arizona, with further increases in hotel occupancy rates and average daily room rates noted.

Demand for District manufactured products picked up a bit, following a mild slowdown during the previous survey period. Orders and sales of semiconductors and other technology products generally remained at high levels. Makers of machine tools and industrial equipment reported that demand expanded and was particularly strong for small and medium-sized capital equipment items. Demand for commercial aircraft and defense products grew further, and makers of these items reported ample capacity to accommodate a rising number of new orders. Manufacturers of certain construction materials, notably wallboard and roofing products, have expanded capacity to meet booming demand, and sales of these products have increased commensurately.

Agriculture and Resource-related Industries
Orders and sales of District agricultural and resource-related products grew further during the survey period of early June through mid-July. Demand was strong and prices generally were stable for dairy products and most fruits and vegetables, particularly for items filling market niches, such as organic foods. Cattle sales and prices remained high, with little or no adverse impact from recently renewed fears about the BSE ("mad cow") virus. In the energy sector, producers of oil and natural gas continued to operate at or near full capacity, and extensive new drilling is underway to help meet steadily growing demand.

Real Estate and Construction
Demand and sales of residential real estate remained vigorous in most parts of the District, and demand for commercial real estate continued to improve. The pace of home sales, price appreciation, and construction was rapid in most areas, fueled in part by rising purchases of second homes and investment properties. The market reportedly heated up further in some areas, such as Seattle, but a few respondents reported evidence of slight cooling in parts of Southern California, where houses remained on the market longer and price appreciation slowed. Demand for commercial real estate strengthened further; office vacancy rates fell and rental rates increased in many District markets, with especially strong demand reported in Southern California. Growth in demand for residential and commercial properties kept overall construction activity at high levels throughout the District.

Financial Institutions
Contacts reported that loan demand was strong overall and credit quality remained good across all loan categories. The number of commercial and industrial loans rose, and demand for construction, commercial real estate, and home loans remained at high levels in most areas and grew further in some.

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Last update: July 27, 2005