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Federal Reserve Districts

Third District--Philadelphia

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Business activity expanded in the Third District in September. Manufacturers, on balance, reported increases in new orders and shipments. Retailers generally reported sales gains in September compared with August and with a year ago. Auto sales were flat from August to September, and below the year-ago level. Overall bank lending rose in September, but the rate of growth slowed from August. Residential real estate demand remained weak, although some builders had increased sales in response to price reductions. Firms reporting on labor costs generally noted a continuing trend of moderate increase in wages, but several said increases in health care benefits costs were large. Firms reported increases in input costs and output prices in September, although the extent of the increases did not appear to have changed much since August. However, there appeared to be more retail price hikes for food products in September than in August.

Third District firms generally foresee continued growth, except in real estate activity, in the next few months. Manufacturers expect increases in demand for their products. Retailers generally expect sales to increase at their current rate, although they are not unanimous. Auto dealers are not certain of the near-term outlook, but most do not expect the sales rate to strengthen. Bankers anticipate slow expansion in business and personal lending, although some expect a pickup from the current growth rate in these credit categories, but they expect residential mortgage lending to remain weak. Home builders and residential real estate agents expect sales to remain slow. Contacts in commercial real estate anticipate steady demand for office and industrial space, and they believe office and infrastructure construction activity might increase late this year and into next year.

Third District manufacturers, on balance, reported increases in shipments and new orders in September. Around one-third of the manufacturers surveyed noted increases and around one-fifth noted decreases. Order backlogs, overall, were unchanged from August to September. Firms producing industrial equipment, paper products, and electrical equipment reported increases in orders in September, but firms producing lumber, metal products, and transportation equipment reported decreases.

Nearly half the manufacturing firms contacted for this report expect increases in new orders and shipments over the next six months, and only a few expect decreases. Manufacturing firms in the region plan to increase capital spending during the next six months, on balance, although firms that produce products and materials for residential construction have trimmed capital spending plans.

Retailers in the Third District reported that sales in September rose from August and from September of last year, although the magnitude of the gains varied. Sales of back-to-school merchandise buoyed results at discount stores, but overall sales growth for these outlets was not strong, and some indicated that the growth rate had slowed from August to September. In contrast, sales of higher price-point goods increased robustly. Sales of fashion items were "well up from last year" according to an executive of a large luxury goods retailer. Merchants said sales of appliances, home furnishings, and home repair and remodeling merchandise continued to be weak. Retailers expect sales to increase in the months ahead at around the current rate. While some expect a strong finish to the year, several of those contacted for this report said the outlook for the year-end holiday shopping period is uncertain.

Auto dealers in the region reported mixed results, but on balance sales were virtually unchanged from August to September, and overall sales remained below the year-ago level. Dealers are uncertain of the course of sales for the remainder of the year, but most do not expect improvement.

The growth rate of outstanding loans at Third District banks slowed in September, according to lending officers contacted for this report. This slowdown in loan growth seems to be widespread across categories, including business lending, personal lending, and credit card lending. Despite the slowdown in growth of business lending several bankers noted that lending related to mergers, acquisitions, and leveraged buyouts has increased. Demand for residential mortgages remains low. Contacts reported some weakening in asset quality among all credit categories, but indicated that increases in delinquencies have been slight. However, one banker said "residential developers are feeling stress" and several banks have stepped up their monitoring of borrowers involved in commercial and residential development. Looking ahead, bankers generally foresee slower growth in business and personal lending than was the case earlier in the year, although some believe the pace of lending will pick up from its recent slowdown.

Real Estate and Construction
Residential real estate activity continued to be very slow in September, according to home builders and real estate agents contacted for this report, and inventories of both new and existing homes remain high. For the previous few months, builders had reported making large price reductions with little effect on sales, but some builders reported slight increases in sales in September. Although they noted a few "pockets of improvement," with a pickup in sales at the highest and lowest end of their house price ranges, they said that "the middle is dead." Real estate agents reported that existing home sales have declined since August in nearly all parts of the region. Contacts among builders and real estate agents do not expect a quick turnaround until large inventories are whittled down. Several said they expect housing demand to remain subdued for some time, although a contact noted that buyers will "recognize a deal, if you give the houses away."

Commercial real estate firms report that office vacancy rates remain quite low in most of the region, though they have increased in Delaware. Demand for office space has slowly pushed rental rates up over the past few years, and contacts report that gradual rent increases should continue over the next few months. However, new signings for office space hit a lull in the third quarter, though renewals of current leases remained strong. The outlook is mixed; plans for new office buildings were recently announced, but some retail projects have been postponed. Contacts in the construction industry said they expect an increase in infrastructure projects this year and next.

Business services firms generally reported steady growth, and some information technology firms indicated that growth in demand for their services had recently picked up. Employment agencies and temporary help firms reported that demand for workers has been rising fairly steadily, overall. They noted that demand for workers in health services, information technology, and accounting had increased, but demand for workers in the financial and real estate industries had decreased. Service-sector firms generally expect business to continue to increase in the months ahead at around the current pace, although a large business services firm noted "some trepidation" among its customers about purchasing more services than they currently do.

Prices and Wages
Reports of increases in input costs and output prices from Third District business contacts were about as prevalent in September as they were in August. Manufacturers noted increases in prices of food products, chemicals, and machinery, but also reported some declines in prices of lumber, transportation equipment, and some metals. Construction companies noted that competition among builders for commercial projects has increased as residential construction activity has declined. One builder noted that "jobs that once had three to four bidders now have eight or more." Contacts indicated that the rate of retail price increase has not changed much, although some food prices have risen along with increases in agricultural commodity costs.

Most of the firms reporting on employment costs in September indicated a continuing trend of moderate wage increases. Several firms noted that increases in benefit costs continued to be large, and more firms are looking at ways to limit the increases. As one large employer noted, "health care choices for employees will be limited and they'll pay more" in 2008.

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Last update: October 17, 2007