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Federal Reserve Districts

Twelfth District--San Francisco

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Reports from Twelfth District contacts indicate continued sluggish economic growth in much of the region during January and early February. While prices remained stable for most consumer goods and services, prices for energy and health care increased substantially. In labor markets, firms faced limited upward pressure on wages and salaries but noted continued rapid increases in costs for employee benefits. Many respondents pointed to uncertainties, due in part to geopolitical risks, as having negatively affected both consumer and business spending. Consumers appeared more cautious concerning expenditures on vehicles and travel. Conditions in District manufacturing generally remained weak with limited signs of improvement. The agricultural sector benefited from improved exports and oil and natural gas producers operated at high levels of capacity. Contacts reported continued strength in residential real estate, while commercial real estate remained weak. Bank lending continued recent patterns of rapid growth in residential mortgage loans and weak demand for business credit.

Prices and Wages
Respondents in the District reported that consumer prices generally remained stable in recent weeks. Notable exceptions were energy prices, reflecting jumps in fuel costs, and rapid increases in health-care prices. Contacts noted that retailers had very little pricing power in the face of the slow economy, extensive discounting was common among retailers and automakers.

Persistent weak demand and ample supply in labor markets continued to damp wage and salary pressures in the District in recent weeks. Contacts characterized wages as flat or up modestly. However, health care and other benefits expenses continued to increase rapidly.

Retail Trade and Services
District respondents reported that the generally sluggish economy and uncertainties related to possible military action in Iraq contributed to lackluster performance in the retail sector during the most recent survey period. Sales of new and used vehicles slowed in January and early February, both relative to December and to a year earlier. Automobile dealers noted that, with the rise in gasoline prices, inventories of SUVs and light trucks rose in several markets. Indicative of more general weakness in retail, sales of apparel reportedly were flat.

District respondents reported continued weak demand for many services in January and early February. Demand for accounting and legal services remained soft in parts of the District; in California, a large law firm catering to the technology sector closed. Transportation providers faced higher costs from rising fuel prices and uncertain future demand associated with a potential war in Iraq. Conditions in District travel and tourism were mixed. In Hawaii, for example, both domestic and international tourism continued to improve; however, the improvement was below expectations and the level of international tourism still has not recovered fully after slumping in 2001. Looking forward, District travel and hospitality industry contacts indicated that adverse effects on tourism from a potential war would more than offset any positive effects associated with the weakening value of the dollar in the foreign exchange market.

Conditions in manufacturing generally remain weak in the District, with respondents noting limited improvement in January and early February. Demand conditions remained relatively stable in biotech industries, while weakness persisted in telecommunications. Respondents noted that semiconductor sales were flat to up modestly and inventories rose slightly. Capacity utilization in parts of the high-tech sector improved; utilization rates reportedly were high and, in some cases, capacity is being expanded for cutting edge technologies. Overall, however, District firms remain cautious about spending. District contacts reported that manufacturers, especially those facing rising energy costs and uncertainties related to a potential war, have postponed spending and investment decisions. Contacts also cited disruptions to businesses from the call-up of military reservists. However, several contacts noted that defense contractors in Southern California and other areas of the District would benefit from the federal government's increased spending on defense and homeland security. Several respondents reported that the fall in the value of the dollar over the past year has positioned District manufacturers to compete more effectively against foreign firms in the months ahead.

Agriculture and Resource-related Industries
The agricultural sector, on balance, benefited from increased exports, while the oil and natural gas extraction sector was marked by high capacity utilization and rising prices. Prices for specialty farm products have been mixed in recent weeks. Prices for raisin grapes fell considerably, while prices for certain nut crops were higher than they were a year ago. Respondents noted that the depreciation of the dollar contributed to higher export volumes for a variety of agricultural products, notably nut crops and beef. High levels of capacity utilization and reduced inventories in oil and natural gas production continued to put upward pressure on energy prices. Ongoing and potential disruptions of foreign energy supplies also affected energy prices.

Real Estate and Construction
Overall conditions in District real estate remained mixed, with commercial real estate markets still in a serious slump and residential markets still showing strength in recent weeks. Commercial office vacancy rates remained high and continued to edge up as leases expired. Rental rates fell, most notably in the San Francisco Bay Area, and new office construction is not expected to pick up for some time.

In contrast, contacts indicated that residential housing markets across much of the District remained robust in January and early February. Sales of low-to-median priced homes remained high in most of the District, especially in Southern California and Hawaii, although the pace of sales and of price appreciation has moderated in some areas. Throughout the District, contacts noted that markets for high-end homes had cooled off. Respondents attributed continued strength in overall home sales primarily to low mortgage interest rates.

Financial Institutions
District banking industry respondents noted strong performance among community banks in January and early February, with most depicting asset quality as remaining good. Residential mortgage loan growth rates continued to climb. Home mortgage refinancing activity was very brisk, though some lenders reported the pace of applications fell short of the pace of loan closings. Business lending remained weak.

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Last update: March 5, 2003