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Federal Reserve Districts

Twelfth District--San Francisco

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Economic activity in the Twelfth District expanded during late July and August at the solid but reduced pace established in the previous survey period. Wage and price inflation were limited on net, with reports indicating substantial variation across sectors in the degree of wage and price pressures. Reports on retail sales suggested modest growth overall, while demand for most services continued to expand at a brisk pace. Demand and sales remained strong for manufacturers and producers of agricultural and resource-related products. Residential construction activity, sales, and price appreciation continued to decelerate in most areas, while commercial real estate activity expanded further. District banks reported solid loan demand on net, although residential mortgage lending slowed further.

Wages and Prices
District reports indicated that overall price inflation remained modest. Energy cost increases moderated, although some contacts noted that the pass-through of earlier increases in energy costs exerted significant upward pressure on final prices of selected energy-intensive goods and services, such as construction materials and transportation services. Price movements more generally were mixed. Some contacts reported increased pricing power and larger price increases for some retail items and manufactured goods, while others noted flat or declining prices for selected building inputs and for products in very competitive markets, notably apparel and electronic goods. District labor markets were largely stable, with little or no change in tightness evident, and wages continued to rise at a moderate pace overall. A few contacts reported a recent reduction in wage pressures, although wage increases remained rapid for workers with specialized skills in various sectors, notably in financial and health services.

Retail Trade and Services
Growth in District retail sales was modest on net. Sales grew somewhat for department stores and assorted specialty retail establishments, although sales slowed for establishments specializing in products used for home improvement. Demand for automobiles changed little from the previous survey period. High gas prices reportedly held down demand for fuel-inefficient vehicles such as large SUVs and light trucks, while sales of selected fuel-efficient imported vehicles continued at a solid clip.

Most service providers saw robust demand. Activity rose further in the health-care, transportation, and professional services sectors. Travel and tourist activity remained at very high levels in most major District markets; contacts provided no reports of adverse effects from heightened airport security arising from the recently uncovered terrorist plot in the United Kingdom, although it may be too early for these effects to appear. In Hawaii, rising domestic tourist arrivals and spending continued to offset a decline in Japanese tourism and generate solid gains overall, although hotel occupancies were down a bit from year-earlier levels.

Demand for District manufactured products was strong on net during the survey period of late July and August. Semiconductor orders and sales grew at a solid pace, largely in line with industry sales forecasts; inventories were balanced and capacity utilization remained at or above 90 percent for many products. In the commercial aircraft sector, further growth in orders and an existing backlog kept manufacturing establishments operating near full capacity in the Pacific Northwest. Contacts reported good demand growth and balanced inventories for processed food. By contrast, apparel manufacturers reported slightly slower orders and sales. Demand fell for various building materials that are primarily intended for residential construction, but one respondent noted rising demand for fabricated metals due to increased nonresidential construction activity. District manufacturers reported plans to increase capital spending during the second half of 2006 at about the same pace as during the first half.

Agriculture and Resource-related Industries
Demand for District agricultural and resource-related products was strong during the most recent survey period. Sales were robust for most crops, notably for potatoes and various nuts, and weather conditions generally were favorable, keeping production on track for most crops and livestock. Elevated prices for fuel and fertilizers remained a concern for many agricultural producers, putting upward pressure on final prices; however, this was partly offset in some areas by increased labor availability and a corresponding reduction in wage pressures arising from reduced demand for labor in the residential construction sector. In the resources sector, producers of oil and natural gas saw robust demand and little or no excess capacity. However, inventories of natural gas remained high, further reducing prices.

Real Estate and Construction
Demand for residential real estate fell further in most areas, while activity in commercial real estate markets continued to expand. In most parts of the District, reduced home demand caused further increases in the inventory of available homes and continued declines in the pace of home sales and price appreciation. The cooler sales conditions damped residential construction activity in most areas. However, construction activity for commercial and public structures rose further. In some areas, builders continued to face significant cost increases and project delays due to tight supplies of skilled workers and selected construction materials. Vacancy rates on commercial space fell further in most parts of the District, and rental rates continued to rise.

Financial Institutions
District banking contacts reported solid loan demand and good credit quality overall. Demand for commercial and industrial loans and for commercial real estate loans has been strong and grew further in some areas, while residential mortgage originations and refinancing activity continued to slow. Contacts reported that indicators of credit quality, such as loan delinquencies, were at favorable levels in general. Several banking contacts reported ongoing increases in capital spending on information technology equipment, partly as a means to offset growing labor shortages for some groups of workers.

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Last update: September 6, 2006