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Federal Reserve Districts

Twelfth District--San Francisco

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Twelfth District contacts reported sluggish growth in economic activity during late November and December, with little change in most industries from trends reported in the previous survey. Regarding prices, reports indicated widespread heavy discounting among retailers and little upward pressure on prices for most other sectors. Increases in wages and salaries were modest, and employers passed on some of the increases in health-care costs to workers. Aside from strength in selected products, holiday spending by consumers was flat to slightly down relative to last year. Conditions in District manufacturing were mixed, with improvements in the sales of selected semiconductor products and expansion in defense-related industries. In contrast, demand in the commercial aircraft and telecommunications markets remained weak. District manufacturers noted continued excess capacity and muted long-term investment activity and research and development (R&D) spending. The weakening of the dollar boosted exports of District agricultural products. Commercial real estate remained stagnant across District markets, while home sales were at elevated levels, although the pace of growth abated slightly. Bank contacts reported continued growth in deposits but continued weak demand for business loans in most areas.

Prices and Wages
Respondents in the District reported that in recent weeks prices exhibited very little upward movement. One exception was energy; contacts noted high levels of capacity utilization for producers of natural gas and electricity services, suggesting possible upward pressure on energy prices in the near term. Among retail trade sectors, businesses perceived little pricing power, which led to deep discounting during the holiday season.

Labor markets for most types of jobs appear tilted in favor of employers according to survey respondents, and layoffs continued in selected retail, services, and high-tech industries. District firms passed on some of the increases in health-care costs to workers by requiring them to pay a greater share of premiums, reducing benefits, and/or slowing wage growth. The combination of the increase in costs of employer-provided health benefits, the weak labor market, and limited pricing power in most industries restrained growth in employee wages and salaries during late November and December, according to District contacts.

Retail Trade and Services
District contacts reported that, with the exception of Hawaii, overall holiday retail revenues were flat or slightly down relative to last year. This lackluster performance was well below expectations. Heavy discounting appeared to be pervasive and substantially greater than during the same period last year. Discount stores reportedly performed better than department stores and establishments specializing in certain high-end products. Consumer durables, especially electronics such as DVDs and cellular phones, sold well in recent weeks, particularly those at the lower end of the price spectrum. Respondents noted that Internet sales, though still miniscule relative to in-store sales, were up considerably from a year ago.

The services sector continued to face weak demand in late November and December. Contacts in advertising and related businesses noted that demand for their services was soft in recent weeks. Conditions in District travel and tourism sectors generally were mixed during the survey period; international visitor counts remained weak, while domestic tourism continued to improve. Contacts reported normal hotel occupancy rates in Hawaii in recent weeks, and time-shares continued to provide a stable source of tourism to the state. Moreover, early season ski bookings at District skiing destinations were up from previous years. In some other areas, though, hotels and other lodging establishments continued to struggle with low occupancy rates.

District manufacturing conditions remained mixed in recent weeks. Sales of semiconductors have continued to improve over a year ago, notably for wireless technologies. Demand conditions remained relatively stable in biotech industries. Defense-related manufacturing, particularly in Southern California, strengthened due to heavy spending by the federal government related to homeland security and possible military action in Iraq. In contrast, the tepid demand for commercial aircraft and telecommunications products has not improved since the last survey period, and District producers of these products continued to grapple with considerable excess capacity.

Excess capacity also remained an issue for most other District manufacturers. Contacts noted that capacity utilization generally remained below targeted levels, and it would likely take six months to a year for manufacturers to reach targeted levels at the current pace of expansion. The excess capacity in District manufacturing establishments is expected to be a drag on capital expenditures in the months ahead. Respondents noted that planned R&D outlays by many manufacturing firms also have been curtailed, both in absolute terms and relative to capital expenditures. An exception to the general rule of excess capacity and slow growth in R&D was the biotech industry, with firms reportedly nearing targeted levels of capacity utilization and experiencing continued expansion in R&D budgets in recent weeks.

Agriculture and Resource-related Industries
Overall conditions for District agricultural and resource-related businesses improved slightly during the survey period. District contacts noted that the weakening of the dollar boosted exports and allowed higher prices in both domestic and foreign markets for agricultural and resource-based products. Respondents reported high capacity utilization in natural gas and electricity services, which could put upward pressure on prices in the near term as well as lead to increased capital expenditures.

Real Estate and Construction
Conditions in District real estate changed little in the survey period. Commercial real estate remained stagnant across District markets. Contacts noted that commercial real estate likely will experience very little new construction in 2003, as high office vacancy rates in markets such as the San Francisco Bay Area likely will restrain new construction for as long as two years. On the other hand, contacts noted that office rental prices in San Francisco appeared to have hit bottom in recent weeks, and that downtown Los Angeles ended 2002 with office vacancies on the decline.

Home sales remained at elevated levels, although the pace of growth in sales slipped a bit further in late November and December. Prices for both single family homes and condominiums continued to increase in many District markets.

Financial Institutions
District contacts reported continued growth in deposits, while nonresidential loan demand weakened further in some areas in the survey period. Banks reported high levels of liquidity but weak demand for business loans.

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Last update: January 15, 2003