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Federal Reserve Districts

Twelfth District--San Francisco

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Economic activity in the Twelfth District continued to expand at a moderate pace on net during the survey period of October through mid-November. Reduced energy prices reversed upward price pressures for some products, while the pace of wage growth remained contained overall but exerted upward price pressures in some industries and areas. District retailers generally reported improved sales and service providers saw strong demand. Orders and output grew further for most manufacturers and agricultural producers. District housing markets continued to cool, while demand for commercial real estate expanded but at a slower pace than previously. Banks reported solid loan demand and good credit quality in general.

Wages and Prices
Upward price pressures diminished somewhat, as prices for energy and related products receded from previously high levels, reducing overall production costs in some sectors. Prices fell further for selected building materials used primarily for residential construction. More generally, respondents noted relatively stable input prices. The primary exceptions were selected commodities such as flour and sugar: significant price increases of late for these inputs are expected to show up in the final prices of some food products in early 2007.

Overall wage growth remained moderate. However, wage growth continued to be more rapid for selected groups of skilled workers, notably in the health-care, finance, and construction sectors, and in areas with very tight labor markets overall, such as Idaho and Utah. Scattered reports also suggested employers were becoming increasingly reliant on using hiring bonuses to recruit skilled workers who are in short supply. These compensation increases exerted noticeable upward pressure on final prices in some cases.

Retail Trade and Services
District retailers reported improved sales growth and balanced inventories for items other than motor vehicles. Sales at department stores and specialty shops picked up relative to the previous survey period, spurred in part by increased spending power arising from lower gasoline prices. Considering early sales figures, retailers are cautiously optimistic in their forecasts for the holiday season as a whole, with expected sales growth generally in the range of 4 to 6 percent relative to last year. Demand for automobiles weakened slightly compared with the previous survey period. Sales of fuel-efficient import vehicles continued at a solid but slightly reduced pace, while the recent drop in fuel prices did little to offset sluggish sales for large, fuel-inefficient domestic models; inventories of domestic light trucks and SUVs reportedly were at record highs.

Service providers reported generally strong demand. Sales grew significantly in the food and beverage, health-care, and transportation sectors. Contacts in various sectors reported that fuel surcharges have been trimmed due to lower energy costs, reducing the price of transportation services. Overall tourist activity remained at high levels, although a Southern California contact noted that recent convention business there has not kept pace with last year.

Demand for District manufactured products expanded further in October and early November. Sales of semiconductors grew at a solid pace in line with industry forecasts, and capacity utilization generally remained in the range of 90 percent. Producers of commercial aircraft and their parts suppliers continued to operate at full capacity to meet ongoing order backlogs, while makers of machine tools indicated that new orders grew but at a slightly reduced pace. Food manufacturers reported continued strong sales. By contrast, demand for selected building materials used primarily for home building fell further, and some sawmills in the Pacific Northwest have sharply curtailed production or closed due to reduced demand for wood products.

Agriculture and Resource-related Industries
Demand for District agricultural and resource-related products was strong and production conditions were stable overall. Sales rose for livestock and most crops, and prices received for these items increased compared with a year ago, notably for selected commodities such as corn. Prices for fertilizers and freight services have fallen significantly, easing upward pressures on production costs. In the resources sector, producers of oil and natural gas continued to see robust demand, although one contact reported that demand for natural gas slowed somewhat due to reduced sales of new homes.

Real Estate and Construction
Activity in residential real estate markets fell further, while demand for commercial real estate expanded but at a slower pace than previously in some areas. The pace of home sales and price appreciation continued to slow for existing and new homes, with particularly weak conditions noted for the latter. To work down unsold inventory, home builders have been offering significant incentives to entice buyers; these incentives reportedly have been valued as high as 10 percent of the listed prices. Residential construction activity has fallen substantially along with demand for homes. On the nonresidential side, vacancy rates for commercial space fell further and rents rose a bit in most areas. Construction activity for commercial and public projects continued to expand, largely offsetting the decline in residential construction, although the pace of growth was slower than earlier in the year. Some contacts noted that investors and builders have grown more cautious about committing to nonresidential projects, due in part to the high costs of land, labor, and building materials.

Financial Institutions
District banking contacts reported solid loan demand and good credit quality overall. Further growth in commercial and industrial loans continued to offset declines in residential mortgage originations. Demand for consumer loans fell slightly in some areas but remained relatively strong. Credit quality was high in general with few delinquencies. However, contacts provided scattered reports of delinquencies on loans to home builders, and banks have increased their vigilance over these loans. Venture capital and private equity financing reportedly remained on a modest but steady growth path.

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Last update: November 29, 2006