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Federal Reserve Districts

Third District--Philadelphia

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Economic activity in the Third District grew slowly in November. Manufacturers reported increases in shipments and new orders during the month. Retail sales of general merchandise were on the rise, but year-to-year gains were slight for most stores and some had declines. Auto sales rose in November, following a drop in October. Bank loan volume was roughly steady. Commercial real estate markets have tightened, but residential real estate activity has eased. Business contacts in all industries noted continued rising costs and growing pressure on profit margins.

Third District business contacts generally expect business activity in the region to continue to expand, although slowly in some sectors. Manufacturers expect business to pick up from its November pace, and they are scheduling increased capital outlays. Retailers anticipate modest year-over-year gains for the holiday shopping period, but they expect sales growth to be difficult to sustain next year. Auto dealers say the outlook is uncertain. Contacts in commercial real estate generally expect further declines in vacancy rates and some firming in rents. Residential real estate agents and home builders anticipate a slight slowing in sales and a moderation in the rate of home price appreciation next year.

Manufacturers in the Third District reported moderate growth in demand for their products in November. About one-third of the companies contacted said that new orders received in November rose from the previous month; about one-fifth said that new orders declined. On balance, shipments increased among area manufacturers, but order backlogs fell. Among the District's major manufacturing sectors, business improved in November for producers of food products, metal products, and electrical equipment, but weakened for makers of apparel, paper products, and industrial materials and equipment.

Overall, manufacturers expect growth in business activity to pick up in the months ahead. Half of the firms contacted in November expect their shipments and orders to increase during the next six months; less than one-fifth expect decreases. Capital spending plans among District manufacturers call for stepped-up expenditures, on balance, and the number of firms scheduling increased outlays has increased somewhat since the summer.

Area manufacturers noted continuing increases in input costs and output prices in November. Over half of the firms surveyed reported higher costs for the goods they purchase, and one-third raised prices for the products they make. Almost none indicated declines in input or output prices. Looking toward next year, about three-fourths of the manufacturers polled in November expect further increases in costs for energy, raw materials, and intermediate goods, and about nine-tenths expect increases in health benefit costs and wages. Energy costs and health benefits are expected to rise more rapidly than other expense categories.

Most of the retailers contacted for this report indicated that sales in October and early November were up only marginally from the same period last year, and some stores posted lower sales. Sales of luxury goods and consumer electronics continued to expand more strongly than other lines of merchandise, and discount stores had better results than mid-price department and specialty stores. Most of the retailers surveyed also reported declines in store traffic month-to-month and compared with a year ago. In general, store executives said they were maintaining cautious inventory levels, although some stores have implemented early price cuts to spur holiday shopping. Third District merchants expect modest year-over-year gains for the holiday shopping period, and looking ahead, several said they expect 2006 to be a challenging year for sales growth. Store executives also noted that profit margins are coming under increasing pressure as a result of the rising cost of utilities, especially heat and electricity, and higher charges for construction and repair.

Auto dealers in the region reported a gradual improvement in sales of both automobiles and sport utility vehicles in November, following a drop in October. Inventories were not considered excessive, but most dealers believe manufacturers' discounts will be needed to prevent the sales rate from faltering. Dealers say the outlook for sales this winter is uncertain and will depend crucially on manufacturers' pricing, the price of gasoline, and the level of consumer confidence.

The volume of loans outstanding at Third District banks was roughly steady in November compared with October. Banks gave mixed reports on commercial and industrial lending; overall, however, business lending appeared to be growing slightly in the region. Consumer loan volume at banks in the District was nearly flat during the month. Most banks and other mortgage lenders in the region indicated that residential mortgage activity has eased. All the financial companies contacted for this report indicated that competition for loans, as well as deposits, continues to be strong. Several banks said they have raised deposit interest rates to prevent outflows. Bankers in the District expect slow growth in lending growth during the winter. They believe that business and consumer confidence has become more fragile recently, prompting more cautious spending for both business expansion and personal expenditures. Bankers and mortgage lenders also expect residential mortgage activity to ease further, although most expect the level of activity to remain high by historical standards.

Real Estate and Construction
Commercial real estate firms reported that vacancy rates in the region's office markets have declined in the past few months. Rental rates have edged up, and in some local markets landlords have reduced concessions. New buildings recently completed or under construction in Philadelphia's central business district are being leased quickly, and the net increase in the amount of available office space in the city has been limited by the conversion of older office buildings to residential use. For the region as a whole, demand for space has been rising somewhat faster than supply. Commercial real estate contacts expect a further tightening of the region's office markets during the winter. As office markets move into balance, commercial real estate agents believe a pickup in construction will become more likely, and some note that a few speculative buildings are already under construction in suburban markets. Demand for industrial space has also been on the rise, especially for warehouse and distribution space, which constitute a large part of the region's industrial facilities.

Residential real estate agents and homebuilders generally reported a slowing in sales in October and November compared with the pace set earlier this year. Some real estate contacts noted that the number of existing homes for sale has risen recently and the number of offers per house has declined. Nonetheless, real estate agents said many sellers do not seem inclined to accept less than their asking prices. Homebuilders and real estate agents expect sales next year to be below this year's level by a few percentage points, and they expect price appreciation to moderate significantly.

Builders reported rising prices for a variety of construction materials and some difficulty in obtaining sufficient supplies of certain items, such as plastic pipe and roofing materials. Some builders also noted that wages and subcontractors' charges have risen.

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Last update: November 30, 2005