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Federal Reserve Districts

Third District--Philadelphia

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Business activity increased slightly in the Third District in December, although the real estate sector continued to be soft. Manufacturers, on balance, reported modest increases in new orders and shipments. Retailers generally reported small increases in sales for the holiday shopping period compared with the previous year. Auto sales showed little change from November to December and remained below the level of a year ago. Overall bank lending has been rising slowly, with better growth in business lending than in consumer and real estate lending. Residential real estate sales remained well below the level of this time last year. Commercial building leasing and sales have slowed. Service-sector firms generally indicated that their business has been expanding steadily, although employment agencies and temporary help firms reported slower growth in demand as 2007 came to an end. Firms reporting on labor costs generally noted a continuing trend of moderate increase in wages, but they continued to report large increases in health care benefits costs. Reports of increases in input costs and output prices were about as prevalent in December as they were in November, although more firms indicated that they were raising the prices of their own goods and services to cover higher motor fuel and energy costs.

Third District firms generally foresee continued growth, but most of those contacted for this report have scaled back their forecasts for 2008. Manufacturers, on balance, expect increases in demand for their products, but the number forecasting increases has declined since a month ago. Retailers generally expect slow sales growth during the year. However, auto dealers generally expect sales in 2008 to be somewhat less than sales in 2007. Bankers anticipate slow expansion in overall lending, with gains coming largely from business lending; they expect little expansion in consumer and real estate lending. Residential real estate agents expect sales to remain sluggish. Contacts in commercial real estate anticipate slower leasing and purchasing activity as markets adjust to reduced credit availability. Service-sector companies generally forecast growth this year to be about as strong as it was last year, but employment agencies expect hiring to be less active, at least in the early part of the year.

Third District manufacturers, on balance, reported rising shipments and new orders in December compared with November. Around one-third of the manufacturers surveyed noted increases and around one-fifth noted decreases. Increased demand for their products was reported by commercial printers and by producers of food products, textiles, apparel, and instruments. Decreased demand was noted by producers of lumber products, construction materials, and metals. For the Third District manufacturing sector as a whole, order backlogs edged down from November to December. Typical comments from Third District manufacturers are that business related to the housing market is “very difficult,” but “there has been an increase in export opportunities” and “reduced import pressure from China.”

The outlook in the Third District manufacturing sector is positive, although the level of optimism has declined somewhat recently. Just under one-third of the firms contacted for this report expect increases in new orders and shipments over the next six months, and nearly one-fourth expect decreases. Despite the modest outlook, Third District manufacturing firms have boosted capital spending plans recently, on balance. Around one-third of the firms in the region plan to increase capital spending during the next six months, and around one-tenth expect to reduce capital spending.

Retailers in the Third District generally reported modest increases in sales for the 2007 holiday shopping period compared with the prior year. Sales of electronic items rose strongly, but sales of most other lines of merchandise showed little or no growth year-over-year. Sales of apparel fell short of most retailers’ expectations, especially at some apparel specialty stores, for which the season was, according to several contacts “a real disappointment.” According to store executives in the District price markdowns were “up a little bit” from last year, but inventory “has been controlled.” Consequently, most stores plan to feature full-price merchandise through the rest of the winter. Third District retail contacts’ outlook for 2008 is cautious. Most expect consumers to restrain spending generally and postpone purchases of big-ticket items in response to uncertainties about housing and overall economic conditions.

Auto dealers in the region generally reported slow sales in December, with most indicating that sales were even with or slightly below the November sales rate. Most dealers indicated that inventories have been fairly steady at manageable levels. Dealers in the region expect sales in 2008 to be below sales in 2007, on balance, although some import dealers expect moderate increases.

Total outstanding loans at Third District banks rose somewhat in December. Commercial bank lending officers contacted for this report generally indicated, as they have for the past several months, that the increase was stronger for commercial and industrial loans, mainly to middle-market firms, than for personal and real estate loans. However, several bankers said that growth in commercial and industrial lending largely continues to fund leveraged buyouts and mergers and acquisitions, with smaller gains in lending to support capital expenditures. Most bank contacts indicated that asset quality overall weakened over the latter half of 2007. Further, they indicated that chargeoffs in 2007 were five to 10 basis points higher than had been projected. Contacts reported that attracting deposits is “an issue,” as competition among banks in the District has been strong. Looking ahead, bankers generally foresee slow growth in overall lending. They continue to expect little improvement in mortgage and personal lending, but most expect growth in business lending to continue to move up at around its current pace.

Investment companies reported strong cash inflows at year-end that boosted outstanding balances in equity, bond, and money market funds. Investment managers reported continuing volatility and some difficulty in trading in fixed-income markets.

Real Estate and Construction
Residential real estate activity in the Third District remained well below its pace of a year ago in the final months of 2007. Residential real estate agents said there were some signs of increased interest among potential buyers, but they do not expect a broad recovery to get under way soon. Commercial real estate contacts said there has been an increase in caution among investors, brokers, and property owners, leading to reduced leasing and sales. Contacts said the decline in leverage in commercial real estate financing has put a brake on building price increases.

Business services firms generally reported steady growth in the final months of 2007, and most of the firms contacted for this report said they expect their sales and revenue for the year as a whole to be close to their forecasts. However, employment agencies and temporary help firms reported that demand for workers has not been growing as strongly recently as it had been through most of 2007. Most of the service-sector firms polled in December expect business to continue to expand in 2008 at about the pace set in 2007, although one large business services firm expects “a rough patch” because its client companies are delaying expansion in response to volatility in credit markets. Employment agencies expect hiring in the Third District to be somewhat less robust in the first quarter of 2008 than it was through most of 2007.

Prices and Wages
Reports of increases in input costs and output prices from Third District business contacts were about as prevalent in December as they were in November. Manufacturers noted increases in prices of food products, chemicals, metals, and machinery. Retailers indicated that their cost of goods rose in 2007, and they expect further, possibly larger increases in 2008. Firms in a wide range of industries continued to report high motor fuel and energy costs, and an increasing number of firms have raised the prices of their own products and services to cover the higher costs. Most of the firms reporting on employment costs in December indicated that wage increases remained moderate. Firms reporting on health care costs continued to mention large increases, and the number of firms reducing health care benefit options and raising employee contributions appears to be growing.

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Last update: January 16, 2008