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Federal Reserve Districts

Twelfth District--San Francisco

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The Twelfth District economy expanded at a solid pace from mid-April through the beginning of June. Price inflation for final goods and services edged up, largely due to the pass-through of earlier increases in energy costs, and tighter labor markets led to a slight increase in upward wage pressure. District retailers and service providers reported strong demand and sales, and manufacturing activity expanded further. Demand for District agricultural and resource-related products was solid, but late-season rains damaged some crops in California. Home sales and price appreciation continued at high rates, and demand for commercial real estate improved further. District banks reported strong loan demand and good credit quality.

Wages and Prices
Contacts reported an increase in inflationary pressure on net, although the pickup largely was limited to products and services for which energy costs are a significant component. Increases in oil prices from earlier this year were passed on to the final prices of various items, including transportation services and energy-intensive goods such as fertilizers and some construction materials. This in turn led to price increases in related industries; for example, prices of packaged food rose as a result of rising delivery costs. Pricing power remained modest more generally, however, with contacts citing vigorous competition from domestic and foreign producers and continued gains in production efficiency as restraining factors.

District labor markets tightened somewhat during the survey period, especially for skilled occupations such as nursing, construction trades, and various jobs in financial services. Contacts from the financial sector reported a recent reemergence of incentive compensation, including signing bonuses to attract qualified workers. Employer costs for health insurance benefits continued to rise, exerting a restraining influence on wage increases for some businesses but reportedly being passed on to final prices in others. General labor market tightening and shortages for some skilled occupations led to increased upward pressure on wages and salaries. However, wage pressures reportedly have subsided somewhat in the manufacturing sector, and reports from various industries suggested that the pace of wage growth more generally remained in the moderate range of 2 to 4 percent.

Retail Trade and Services
District retail sales grew on balance during the survey period. Sales of new and used automobiles remained at high levels overall. However, high gas prices held down relative demand for sport-utility vehicles and light trucks, and substantially more demand strength was evident for foreign than for domestic brands. Sales of smaller retail items grew significantly and inventories reportedly stabilized further.

Service providers continued to see robust demand growth. Demand for media and high-tech services strengthened, while demand growth remained vigorous for providers of food, transportation, and health-care services. The District's travel and tourism sector continued to surge; the number of domestic and international visitors rose further at key destinations such as Hawaii, increasing hotel occupancy rates and average daily room rates from already high levels.

Demand was solid in the manufacturing sector, although the pace of growth has slowed. Semiconductor orders and sales were strong and inventories in balance, but capacity utilization has fallen and sales prices were held down by substantial supply; ample production capacity and limited pricing power were reported for technology products in general. Makers of machine tools and industrial equipment reported that demand remained strong, though new orders slowed. Reports from a variety of industries suggest that business investment spending grew at a steady pace during the survey period. Respondents expect further increases in investment spending during the balance of this year, which will help maintain demand growth for technology products and other capital goods going forward. Conditions in the aerospace sector have improved due to a recent upturn in new orders for commercial aircraft, and defense contractors have been busy filling orders for a variety of items related to national defense. Apparel manufacturers reported little or no change in orders and good availability of raw materials.

Agriculture and Resource-related Industries
Demand for District agricultural and resource-related products remained solid in mid-April through early June. Orders and sales reportedly were strong and prices were stable for cattle, commodity crops such as cotton and hay, citrus fruits, and vegetables. However, contacts reported rising input costs, particularly for fertilizers, and recent heavy rains in California's Central Valley severely damaged the crops of cherries and other tree fruits. In the energy sector, producers operated at or near full capacity in recent weeks, and drilling and distribution of natural gas continued to grow rapidly.

Real Estate and Construction
Demand remained vigorous in residential real estate markets, and conditions improved further on the nonresidential side. The pace of home sales, price appreciation, and home construction was rapid in most parts of the District, although growth reportedly slowed a bit relative to previous periods. Demand for commercial real estate strengthened further in recent weeks, with office vacancy rates and rental rates increasing slightly in some markets. Continued solid demand for new homes plus increased demand for commercial real estate kept overall construction activity at high levels, especially in Southern California, the Las Vegas area, and Hawaii.

Financial Institutions
District banking contacts reported little change from the strong conditions reported in the previous survey period, with strong loan demand and good credit quality. Commercial and industrial lending activity grew further, while demand for construction, commercial real estate, and home loans remained at high levels in most areas. Credit quality in general was good across all loan categories. A very competitive environment and narrow spreads between short-term and long-term interest rates reportedly held down profit margins in the banking sector.

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Last update: June 15, 2005