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Federal Reserve Districts

Third District--Philadelphia

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Economic activity in the Third District expanded moderately in December. Manufacturers reported increases in shipments and new orders during the month. Retail sales of general merchandise during the holiday season were above the same period in the previous year, although the extent of the increases varied from slight for some stores to strong for others. Auto sales eased as 2005 came to a close. Service-sector activity continued to expand at a steady, moderate pace. Business contacts in all industries noted continuing increases in the costs of materials and intermediate goods, and they indicated that wage and salary increases for 2006 will be somewhat greater than they were in 2005.

Third District business contacts generally expect business activity in the region to continue to expand at about its current pace. Manufacturers expect further increases in orders and shipments in the first half of the year. Retailers anticipate slight gains, but many are concerned that high home-heating bills will constrain consumers' discretionary spending. Auto dealers say the outlook is uncertain, and most of those polled at the turn of the year anticipate slower sales in 2006 than in 2005. Contacts among service-sector firms generally expect business to continue to advance at its current rate.

Manufacturing activity in the Third District expanded in December at about the same pace as in November. About one-third of the manufacturing companies polled in December reported that new orders and shipments increased during the month, and about one-fourth reported slower new orders and shipments. Among the District's major manufacturing sectors, business improved relatively more in December for producers of food products, furniture, and electrical equipment. Producers of chemicals and industrial materials noted some slowing in demand for their products during the month, and makers of transportation equipment reported continuing declines in business. In other sectors business was steady or advancing modestly.

Overall, manufacturers expect growth in business activity to pick up during the first half of the year. Half of the firms contacted in December expect their shipments and orders to increase during the next six months; about one-tenth expect decreases. This represents a slight improvement in regional manufacturers' outlook compared with their views in the early fall. On balance, area manufacturers plan to add workers and increase capital spending in the first half of the year.

Third District retailers reported year-over-year increases in holiday sales, although the extent of the gains varied among stores. In a continuation of the year-long trend, luxury-goods retailers posted strong annual increases, while mid-price department stores and discount stores had slight increases. Specialty stores had mixed gains. Sales increased in line with expectations at stores selling electronics and teen apparel, but for home furnishing stores, sales were virtually level with a year ago. Sales increased at adult apparel and accessory stores, although the gains were strong at only a few chains. Area retailers had stocked conservatively for the holiday season, and unplanned discounting was not widespread. Looking ahead, area merchants say the pace of sales will depend on the strength of gains in consumers' income and the impact of the cost of gasoline and home heating during the winter. Several store executives noted that consumers are curtailing shopping trips and limiting spending as they cope with higher energy costs this winter compared with a year ago.

Auto dealers in the region reported a slowing in sales in December. The falloff in sales was relatively greater for light trucks and sport utility vehicles than for cars. Sales of foreign makes did not weaken as much as sales of domestic makes. Dealers indicated that manufacturers' discounts and incentives were not stimulating sales as much as they did in the past, and they expect sales this year to be less than last year.

The volume of loans outstanding at Third District banks increased in December compared with November. Banks in the region posted gains in business, consumer, and residential real estate loans. Commercial bank lending officers said competition for loans continued to be strong. Overall, bankers indicated that credit quality remained good. Bankers in the District expect continued growth in lending to businesses and consumers during the winter. Most of the bankers contacted for this report expect some slowing in residential real estate lending, but most believe the decline is likely to be modest. Several bankers noted that the residential builders they finance are continuing to acquire land, although some builders anticipate that the pace of new home sales will be slower over the next few years than it was over the past several years.

Most of the Third District service firms contacted in December reported that activity continued to expand at a steady, moderate pace, and some noted recent increases in the rate of growth. Business services firms have experienced growing demand from existing customers and new customers. Employment agencies and temporary help firms indicated that demand for workers has picked up recently. Trucking firms reported continuing high rates of activity, resulting in difficulty finding sufficient numbers of drivers. Most of the service-sector firms contacted in December expect business to continue to advance at about its current growth rate through the winter, although some employment agencies are uncertain about how long the recent increase in demand will persist.

Prices and Wages
Business firms in the Third District reported that they face continuing increases in costs of materials and intermediate goods. Although the rise in energy prices has ebbed, Third District firms say the impact of the higher prices will become more serious during the winter as their energy consumption rises seasonally. Many firms said they were reviewing ways to reduce energy use, and more firms plan to increase spending on energy-saving investments in 2006 than increased such spending in 2005. Some firms that have energy-intensive operations indicated they will attempt to recoup higher energy costs through general price increases rather than surcharges.

Employers in a range of industries noted that the salary schedules they are implementing for 2006 will raise wages by a greater percentage than the 2005 increases. Although the average step-up in increases is modest, firms indicated that they will be raising salaries significantly for some hard-to-fill occupational categories in order to retain current employees and to attract new hires. Many firms in the region reported that their employee turnover rates picked up noticeably in the fourth quarter, and employment agencies reported that there has been a recent increase in inquiries about jobs from currently employed workers. Hiring executives cite these developments as indications that labor markets have tightened.

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Last update: January 18, 2006