October 19, 2005 Federal Reserve Districts Third District--Philadelphia

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Economic activity in the Third District advanced slowly in September. Manufacturers reported a slight increase in shipments during the month but a steady rate of new orders. Retail sales of general merchandise rose from August to September, but year-to-year gains were modest for most stores. Auto sales fell in late September and remained slow in early October. Banks and other lenders reported that lending continued to move up in September, but many said loan growth had slowed. Service firms generally indicated that their business activity has been expanding at a steady, moderate rate. Business contacts in all industries expressed concern about rising energy costs and price increases in general. The number of firms reporting pressure on profit margins, primarily from rising energy and material costs, has increased. Many firms are looking for ways to reduce energy expenses but most have not yet made firm plans to implement any energy-saving measures. Third District business contacts generally expect business activity in the region to continue to expand, but several expect growth in the fourth quarter to be slower than in the third quarter. Manufacturers expect business to pick up from the September pace, but not strongly. Retailers anticipate slow growth and difficulty meeting fourth-quarter sales targets. Auto dealers expect slow sales in the months ahead. Bankers anticipate continued growth in lending, but many expect the pace of loan growth to ease. Service firms expect activity to advance at about its current rate through the rest of the year. Manufacturing Manufacturers in the Third District reported generally steady demand for their products in September. About half of the companies contacted said that new orders received during the month were level with orders received in the prior month, and the number of firms reporting decreases was offset by an equal number reporting increases. On balance, shipments increased among area manufacturers, but order backlogs fell. Among the District's major manufacturing sectors, business improved in September for producers of food products, apparel, and industrial materials but weakened for makers of furniture and chemicals. Producers of primary metals and transportation equipment reported continuing declines in orders for their products. Overall, manufacturers expect growth in business activity to pick up in the months ahead. About one-third of the firms contacted in September expect their shipments and orders to increase during the next six months, and one-fourth expect decreases. Capital spending plans among District manufacturers call for stepped-up expenditures, on balance, but in September the number of firms scheduling increased outlays remained somewhat lower than in the first half of the year. Retail Retailers in the Third District, on balance, reported increases in sales from August to September; for most year-over-year gains were modest. Also, the majority of retailers reported a decline in store traffic month-to-month and compared to a year ago. Store executives said the exceptionally warm weather during the month reduced sales of fall apparel. They also said consumers appeared to be limiting discretionary spending in the face of rising energy costs. Stores selling teen-oriented merchandise or luxury goods posted greater annual sales increases than other types of stores. Discount stores had moderate gains. Stores specializing in mid-price merchandise had mixed results; some had slight year-over-year increases, and others had slight decreases. Slow sales of fall apparel have left some stores with large inventories, and they have stepped up price reductions and added sales events to their calendars for October. Looking ahead, most retailers in the region expect sales growth to be slow through the rest of the year. Some said they expect their fourth-quarter results to fall short of plan unless consumer confidence improves. Auto dealers in the region reported a sharp drop in sales as manufacturers' discount programs ended in September. Inventories of 2005 model year vehicles were nearly depleted, except for large sport utility vehicles. Dealers reported a sharp decline in demand for these vehicles. Dealers said sales of new model year vehicles have been slow, and they expect sales for the fourth quarter to remain well below the pace achieved in the first three quarters of the year. Finance The volume of loans outstanding at Third District banks rose in September compared with August and with September of last year. However, banks gave mixed reports on the magnitude of the gains; many indicated that loan growth has been sluggish, although a few said it has been robust. Among major credit categories, growth has been relatively faster for commercial and industrial loans and credit card lending, and less rapid for other types of consumer loans and residential mortgages. All the financial companies contacted for this report indicated that competition for loans, as well as deposits, has been strong among banks and other financial institutions. Bankers and other lenders in the District expect lending to continue to move up at around the current pace for the rest of the year, but several said they expect growth to be slower in 2006 than in 2005. Investment companies reported steady overall cash inflows in recent weeks. They indicated that inflows to money market funds have increased substantially and inflows to bond funds have risen somewhat, but inflows to equity funds have eased. Investment company officials said investor confidence appears to be stable, although both individual and institutional investors have been reluctant to increase the portion of their investments allocated to stocks or long-term bonds. Services Most of the Third District service firms contacted in early October reported continuing moderate growth in activity and at about the same pace as during the summer months. Firms providing information services have picked up some business from new clients. Activity at business services firms has been growing as their existing clients make more use of their services. Trucking firms reported continuing high rates of activity, resulting in difficulty finding sufficient numbers of drivers. Most of the service sector firms contacted for this report expect business to continue to advance at around its current growth rate during the balance of the year. However, firms providing business services noted that their customers are looking for ways to reduce operating expenses in order to cope with rising energy costs, and they expect the amount and price of outsourced services will be reviewed as part of this process. Wages and Prices Business firms in the Third District generally indicated that wages have not been rising at a rapid pace, but nearly all of those surveyed said they face continuing steep increases in benefits costs. Many firms said they were reviewing ways to reduce these costs as they prepare their 2006 budgets. Third District firms in all industries contacted for this report said the costs of their inputs have been rising, and many said the rate of increase has accelerated recently. Firms reported rising prices for a range of basic materials, petroleum-based products, and energy. Firms that purchase large quantities of motor fuels and other energy products have begun to make more use of hedging, and some have instituted other measures to control current and future energy costs, including negotiating long-term and bulk purchase contracts. Trucking firms said fuel costs have reached record highs and they have raised fuel surcharges to their customers. Expectations of further price increases are widespread, and the number of area firms that have raised, or plan to raise, prices for their own goods and services has increased. Executives at many Third District firms say the costs of the goods and services they purchase are rising more rapidly than official price measures. One contact said his firm is developing a cost index to replace the consumer price index for automatic price escalation in long-term contracts. Return to top New York Cleveland