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Federal Reserve Districts

Third District--Philadelphia

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Economic activity in the Third District increased in August, although the rate of growth appeared to ease. Manufacturers' shipments and orders increased. Retail sales of general merchandise rose slightly, but auto sales weakened. Bank lending increased, but not as much as it had in previous months. Residential real estate activity slowed sharply, but commercial real estate markets tightened.

Third District business contacts generally expect business activity in the region to continue to expand, but they have become more cautious in their outlook. Manufacturers expect further gains. Retailers anticipate only modest growth in sales. Auto dealers expect sales to remain slow. Banks anticipate slight gains in business and consumer lending but forecast a further decline in mortgage lending. Commercial real estate contacts expect the demand for office and industrial space to continue, but residential real estate agents and home builders anticipate further declines in home sales.

Business activity picked up in August for manufacturing firms in the region. Around a third of the Third District manufacturing companies contacted for this report said that shipments and new orders rose during the month, twice as many as reported declines. Demand increased in August for metals, industrial materials, and wood products but slipped for transportation equipment and apparel. On balance, area manufacturers reported steady order backlogs and delivery times in August.

Overall, manufacturers expect demand for their products to continue moving up at about the current rate of growth. About 40 percent of the firms contacted in August expect their shipments and orders to increase during the next six months; about 20 percent expect decreases. Capital spending plans reported by Third District manufacturers in August were less robust than they were in previous months. On balance, manufacturers have scheduled only marginal increases in outlays for new plant and equipment during the next six months.

Most of the retailers contacted for this report indicated that sales rose in August, but only slightly compared with August of last year. The back-to-school sales period has not been as strong as many retailers expected. Apparel sales, in particular, have been softer than anticipated. Store executives indicated that discounting has been widespread. Looking ahead, area retailers have subdued forecasts. They believe consumer confidence has weakened, and they expect consumers to limit discretionary spending in the months ahead.

Auto sales in the region slowed in August, and dealer inventories increased. Domestic manufacturers have stepped up incentives to clear out 2006 models before delivery of 2007 models, but most area dealers do not anticipate an upturn in sales.

The volume of loans outstanding at Third District banks rose slightly in August, according to commercial bank lending officers contacted for this report. Commercial and industrial lending increased for most banks. Credit card lending expanded, but other types of personal lending slowed. Demand for residential mortgages eased. While overall credit quality was good, according to bankers contacted for this report, some noted increased delinquencies on residential mortgages.

Bankers in the District expect business and consumer lending to increase in the months ahead, but not strongly. They also expect gains in credit card lending. However, they anticipate a further decline in demand for residential mortgages.

Real Estate and Construction
Commercial real estate firms reported that vacancy rates in the region's office markets have continued to decline in the past few months, and rents have risen. There has been an increase in both speculative and build-to-suit construction of office buildings. Commercial real estate contacts expect a further tightening of the region's office markets this year if the local economy continues to expand. Demand for industrial space in the region continued to grow, and supply has been limited as older buildings have been taken off the market for conversion to non-industrial uses. The limited supply has encouraged an increase in the construction of industrial buildings on both a speculative and build-to-suit basis.

Residential real estate agents and homebuilders reported a sharp slowdown in sales in July and August, compared with the spring months and with July and August of last year. Real estate contacts noted that the number of existing homes for sale and the time they are on the market have been increasing. Price appreciation of existing homes has slowed or stalled in many areas. For new homes, builders are offering more features without charge. Homebuilders and real estate agents expect the pace of sales to slow further during the rest of the year.

Prices and Wages
Business firms in the Third District reported continuing increases in the costs of raw materials and intermediate goods. Manufacturers noted recent increases in prices for metals, petroleum-based products, and energy. Construction firms reported increases in prices for metal products, drywall, and vinyl and plastic products. However, retailers generally indicated that selling prices are not on the rise, and that discounting has been extensive during the back-to-school shopping period.

Employers in many industries reported that labor markets remain tight for both skilled and unskilled workers. In service industries, firms report rising turnover among information technology, finance, and managerial occupations. In contrast, some residential construction companies have laid off workers as demand for new homes has declined. Wages are generally reported to be rising slightly faster now than at this time last year, but salaries offered for positions that are difficult to fill have increased substantially. Firms in all industries continue to report increases in health care costs.

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Last update: September 6, 2006