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Federal Reserve Districts

Twelfth District--San Francisco

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The Twelfth District economy continued to expand at a solid pace from mid-January through February. District contacts reported little change in overall price inflation, despite significant increases for selected producer prices. Upward pressure on wages and salaries remained modest overall. Employers have responded to rising costs for health insurance benefits largely by shifting some of the costs to workers but also by restraining wage growth in some cases. Retail sales mostly were stable, although sales of new automobiles slowed; service providers reported robust demand. District manufacturing activity expanded further and sales of agricultural products were strong. Home demand remained robust, and demand for commercial real estate improved. District banks reported solid loan demand and good credit quality.

Wages and Prices
District contacts reported that overall price inflation remained low in recent weeks. Prices of inputs to producers rose somewhat, notably for surface transportation services, energy and petroleum products, and a variety of construction and industrial materials, especially steel. Consumer prices generally remained stable overall, however, held down by vigorous competition among sellers and continued gains in production efficiency.

Respondents reported little change in labor market conditions. Employers in most sectors experienced little or no difficulty filling job openings. The primary exceptions were selected high-skill jobs in the construction, health-care, and media sectors and jobs in many sectors of the Hawaiian economy, which has been expanding at an unusually rapid pace of late. Wage and salary pressures remained modest in the District overall, with average annual increases mostly in the range of 3 to 4 percent. Most employers faced upward pressure on total compensation due to large ongoing increases in health benefit costs. While there were scattered reports of reduced hiring due to these cost increases, most businesses have responded in other ways: about two-thirds of those surveyed indicated that they have already shifted or plan to shift at least some of the cost increases to employees, while about one-third reported that they have reduced wage and salary growth at their firms to offset rising health-care costs. Several respondents noted slower growth in health-care costs recently, a trend they expect to continue this year.

Retail Trade and Services
Contacts reported largely stable retail sales compared with the previous survey period. Sales of retail merchandise in general were reported as "steady." However, sales of new automobiles weakened; solid sales of imported brands were offset by a dip in sales of domestic brands, due in part to a reduction in sales incentives by domestic manufacturers. Among used vehicles, relatively tight inventories held sales down somewhat and prompted price increases.

Sales of services by District providers have been strong, and they expanded further during the survey period. Demand for health-care and transportation services remained robust, and providers of high-tech services reported improved demand of late. Activity was vibrant in the travel and tourism sector. In Hawaii, domestic visitor arrivals continued at record highs. More generally, hotel occupancy and average daily room rates reportedly were stable or improved further in the District's major tourist destinations, including Southern California and the San Francisco Bay Area.

District manufacturing activity expanded further from mid-January through February. Robust construction activity fueled rising demand for wall board, insulation, and other building materials, and manufacturers of these products reportedly faced significant order backlogs. Makers of machine tools reported solid demand. Among information technology products, semiconductor orders and sales have been solid and they picked up a bit in recent weeks; as in the previous survey period, capacity utilization dipped slightly but is expected to stabilize at a relatively high level in coming months. Contacts reported that conditions in the commercial aircraft sector improved slightly, as an increase in orders from Asia offset weak orders from domestic and European sources. The main exception to solid conditions in the manufacturing sector was in telecommunications, as makers of communications equipment continued to struggle with weak orders and substantial excess capacity.

Agriculture and Resource-related Industries
Conditions in District agricultural markets remained solid during the survey period. Orders and sales of agricultural goods were strong, spurred in part by foreign demand. However, District contacts reported that the tight supply of trucking and rail services and consequent rising prices have reduced the competitiveness of some District producers relative to those outside the region. Recent heavy rains in Southern California had a mixed impact on agricultural supply, damaging some crops but improving conditions for livestock grazing. In the energy sector, distribution of natural gas has been expanding rapidly in response to growth in residential housing, and producers operated at or near full capacity in recent weeks.

Real Estate and Construction
Demand for residential real estate generally remained robust, sustained in part by continued low mortgage rates. Sales of new and existing homes increased throughout the District, and home-price appreciation continued at an elevated pace in most areas. As in the previous survey period, however, in several areas the pace of home sales and price appreciation slowed somewhat from the highs reached in 2004. Continued solid demand for new homes kept overall construction activity at high levels in many areas, while rising costs for building materials prompted some contractors to raise prices. Conditions in District commercial real estate markets improved further in recent weeks. Office vacancy rates fell and rental rates increased modestly in several markets, and commercial construction activity picked up slightly in some areas.

Financial Institutions
District banking contacts reported solid overall loan demand and good credit quality. Commercial and industrial lending edged up, while demand for construction, commercial real estate, and residential loans slowed a bit in some areas but remained at high levels overall. Contacts reported ample availability of credit and noted that a competitive lending environment has narrowed margins in the banking sector.

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Last update: March 9, 2005