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Federal Reserve Districts

Third District--Philadelphia

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Economic activity in the Third District expanded modestly in August. Manufacturers reported increases in orders and shipments. Retail sales of general merchandise rose from July to August, but only matched or slightly exceeded year-ago levels for many stores. Auto sales rose in July and continued to be strong in August. Banks and other lenders reported that business and consumer lending continued on an upward trend in August, but mortgage lending eased during the month after rising in July. Commercial real estate conditions have shown little change in recent months. Sales of both new and existing homes slowed somewhat in August after an increase in July.

Third District business contacts generally expect business activity in the region to continue to expand at a modest pace. Manufacturers expect increases in shipments and orders during the next six months. Retailers anticipate growth but with only slight year-over-year gains. Auto dealers are uncertain about the outlook and many expect the sales rate to decline as new models are introduced and price discounting is curtailed. Bankers expect continued growth in business and consumer lending, but they anticipate a decline in mortgage activity. Contacts in commercial real estate forecast a moderate increase in demand for office and industrial space. Homebuilders and residential real estate agents expect sales to pick up seasonally in the fall as long as mortgage interest rates do not rise substantially from current levels.

Manufacturing activity in the Third District increased in August, according to manufacturing firms contacted during the month. Just over one-third of the companies contacted posted increases in new orders and shipments for the month, and around one-fifth had decreases. Order backlogs edged up in August, although delivery times were unchanged. Among the District's major manufacturing sectors, business improved more for producers of furniture, paper products, and electrical machinery. Most other sectors experienced slight gains, although producers of primary metals and transportation equipment reported some slowing in business.

On balance, manufacturers expect continued growth in business activity. About four out of ten of the firms contacted in August expect their shipments and orders to increase during the next six months, and one out of ten expect decreases. Roughly the same number of firms gave positive forecasts in August as in July, but there has been a decline in the number of firms giving negative forecasts. Capital spending plans among District manufacturers call for stepped up expenditures, on balance, but the number of firms scheduling increased outlays remains somewhat lower than in the first half of the year.

Reports of price increases from Third District manufacturers outnumbered reports of decreases in August, although a majority of manufacturing firms reported steady prices for the month. One in three of the manufacturing firms contacted for this report noted increases in input prices in August, and one in eight raised output prices. Fewer than one in ten reported declines in either input or output prices. The number of firms noting increases in input prices has not changed for the past several months, although the number reporting increases in output prices has declined. During the next six months, about half of the manufacturers surveyed expect increases in input prices, and about one-third plan to increase the prices of their own goods; only a very small percentage expect declines in either input or output prices. Expectations of further increases in energy prices are widespread among Third District manufacturers, and many also expect increases in the prices of raw materials and intermediate inputs.

Retailers generally reported a slow start to back-to-school shopping in August. Although sales increased from July, several merchants indicated that their August sales were just even with or only slightly higher than sales in August of last year. Store executives said the exceptionally warm weather during the month reduced store traffic and reduced sales of fall apparel. Stores specializing in mid-price and low-price merchandise continued to report slower sales growth than stores specializing in higher-price goods.

Retailers in the region expect sales growth to pick up in the weeks ahead, but not strongly. Merchants generally believe consumers are limiting spending as they cope with rising gasoline prices. Looking ahead to the fourth quarter, several of the retail executives interviewed for this report said the outlook is becoming more uncertain; they cite declines in store traffic and uneven sales growth as signs that consumer confidence is slipping.

Auto dealers in the region reported a continued high rate of sales in August as manufacturers extended price discounts. Inventories of 2005 model year vehicles were low, except for large sport utility vehicles. Dealers reported a sharp decline in demand for these vehicles. Dealers expressed some concern that sales of 2006 models will be slow, following the high rate of sales in the past few months and the scheduled end of the current discount programs.

The volume of loans outstanding at Third District banks rose from July to August, according to banks surveyed for this report. Commercial and industrial loans have been increasing at a roughly steady pace. Consumer loans and credit card lending have also been moving up. Lending for residential mortgages eased in August, following an increase in July. However, mortgage lenders indicated that the decrease was slight, and that the volume of new mortgage loans remained high for home purchases as well as refinancing. Bankers and other lenders in the District expect business and consumer lending to continue to move up at around the current pace, but they expect mortgage lending to decline.

Real Estate and Construction
Commercial real estate firms reported that vacancy rates in the region's office markets have been roughly steady in the past few months. Rental rates have also been about steady, although in some local markets landlords have reduced concessions. Leasing activity has been fairly strong, and there has been a slight increase in build-to-suit construction in some areas. Commercial real estate agents expect a tightening in the region's office markets during the second half of the year, although the scheduled completion of a large building in Philadelphia's central business district at the end of the year is expected to prevent a substantial decrease in the city's vacancy rate. Industrial building vacancy rates have been nearly flat in recent months, and rents have shown little change. Commercial real estate contacts believe demand for industrial space will grow about in line with overall economic expansion during the rest of the year.

Residential real estate agents and homebuilders generally reported a seasonal slowing in sales in August. Nevertheless, they indicated that the pace of sales continued to be strong. Some real estate contacts noted that existing homes for sale seem to be on the market longer now than earlier in the year. They believe this might be due to sellers setting unrealistically high asking prices. In general, real estate agents said the inventory of homes for sale remains low. Homebuilders and real estate agents expect the sales rate to pick up somewhat in the months ahead; however, several of those contacted for this report believe any increase in mortgage interest rates could reduce home sales significantly.

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Last update: September 7, 2005