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Federal Reserve Districts

Twelfth District--San Francisco

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The Twelfth District's solid economic expansion remained on track during the survey period of mid-January through the beginning of March. Contacts reported modest price and wage inflation on net, despite elevated prices for energy-intensive products and faster wage growth for scattered groups of workers with specialized skills. Retail sales grew compared with year-earlier levels, and service providers saw robust demand. District manufacturers reported generally solid demand. Orders and sales grew for providers of agricultural and resource-related products. Activity in residential real estate markets generally remained at high levels but slowed further in some areas, while demand for commercial real estate continued to improve. District banks reported net growth in loan demand and very good credit quality.

Wages and Prices
Contacts reported little or no change from the modest inflationary pressures reported in the previous survey period. Continued productivity gains reportedly held down increases in final prices in most sectors, and nearly all contacts expect the existing trend pace of productivity growth to be maintained or to pick up in 2006. The prices of energy-intensive production inputs remained quite high and rose further in some cases, but the availability of selected construction materials improved and their prices stabilized or fell slightly in some areas.

The pace of wage growth was moderate on net, with increases generally in the range of 3 to 5 percent or less on an annual basis. However, wage gains were rapid for scattered groups of workers with specialized skills in the financial, construction, health-care services, and information technology sectors; some of these worker groups have seen double-digit wage growth over the past year.

Retail Trade and Services
Contacts reported solid retail sales, with gains evident relative to year-earlier levels. Sales grew in most market segments, although performance varied substantially across individual retailers within segments. Automobile sales were very strong in January. However, preliminary information suggests spotty sales of new vehicles in February, and throughout the survey period demand remained stronger for imports than for domestic makes.

Service providers saw robust demand in general. Orders and sales grew further in the food and beverage, health-care, and transportation sectors. Intense competition held down sales for individual service providers in some sectors, such as media services and telecommunications, but past and ongoing investments in technologies that enhance efficiency helped these businesses maintain profit margins. District travel and tourism activity was vigorous, notably in Hawaii, where visitor counts and spending remained on the record-setting pace established in 2005. Tourist activity also was strong in California; hotel occupancy rates reportedly showed signs of stabilizing at high levels in the San Francisco Bay Area, but room rates rose further.

District manufacturers reported generally solid demand for their products during mid-January through the beginning of March, with slight slowing evident in some sectors compared with the previous survey period. Orders and sales of semiconductors were strong, and capacity utilization remained at high levels; inventories reportedly were in balance based on recent and expected demand growth. By contrast, a maker of metal products described conditions as "tepid" compared with the robust demand experienced in late 2005. District food processors reported a slight slowing in sales relative to the rapid pace established in 2005, although they expect this slowdown to be temporary.

Agriculture and Resource-related Industries
Providers of agricultural and resource-related products reported further demand growth and generally good supply conditions. Mild weather resulted in an unusually abundant supply of fruits, vegetables, and flowers for this time of year, and material costs were largely stable. However, contacts in California expressed concern that increasingly tight supplies of agricultural labor may interrupt harvests in coming months. In the resource sector, producers of oil and natural gas saw robust demand; they continued to operate at close to full capacity but faced difficulties and delays in hiring skilled workers and obtaining raw materials. Producers facing input constraints in both the agricultural and resource sectors reportedly maintained output in part through the implementation of productivity-enhancing equipment and technologies.

Real Estate and Construction
Activity in residential real estate markets continued at high levels but showed further evidence of softening in some areas. The pace of home construction and sales was rapid in general, and sales prices held steady or increased in most areas. However, a decline in the pace of home sales and slowdowns in other indicators reflect significant cooling in some previously hot markets, notably in Hawaii, Arizona, and parts of California. On the non-residential side, office vacancy rates continued to fall and rental rates rose further in most major markets, and building activity has picked up for commercial projects and public structures. Construction costs also rose further in some areas, due to elevated prices on selected materials and higher wages for skilled workers.

Financial Institutions
District banking contacts reported growing loan demand and very good credit quality overall. Mortgage lending slowed slightly, but demand for commercial and industrial loans continued to advance, as did loan demand for commercial real estate and construction projects. Contacts also noted increases in venture capital activity in parts of the District. In an environment of intense competition, narrow interest rate spreads, and rising compensation costs, many banks reportedly have been relying on technology investments and organizational efficiencies to maintain profit margins.

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Last update: March 15, 2006