January 17, 2007 Federal Reserve Districts Third District--Philadelphia

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Economic activity in the Third District advanced modestly in December. Manufacturers posted small increases in shipments, but there was virtually no change in the rate of new orders. Retail sales of general merchandise rose slightly. However, auto sales remained weak. Bank lending increased moderately overall, but mortgage lending declined. Service sector activity increased at a nearly steady rate in December compared with previous months. Third District business contacts generally expect business activity to continue to expand at a steady rate, although several of those polled for this report said the outlook has become more uncertain. Manufacturers expect modest improvement during the first half of the year. Retailers generally expect a steady, albeit slight, gain in sales, although some believe the growth rate might slow further. Auto dealers do not expect sales to pick up in the near future. Bankers generally anticipate increases in business and consumer lending, but their views of mortgage lending are mixed; some expect an increase, but others do not. Service-sector firms expect steady growth in the months ahead. Manufacturing Third District manufacturers reported an increase in shipments from November to December, although the rate of new orders was about steady. The increase in shipments was more prevalent among makers of food products, furniture, and machinery than among other manufacturing sectors in the District. Increases in orders were noted among only a few sectors, mainly producers of food products and textiles; in most other sectors orders were either steady or down. On balance, District manufacturers reported an easing in order backlogs and a decrease in delivery times. Overall, manufacturers expect demand for their products to increase during the first half of the year, but they forecast only modest gains. Among the manufacturers contacted in December, one-third expect their shipments and orders to increase during the first six months of 2007; one-fifth expect decreases. Capital spending plans among Third District manufacturers appear to be moderating. Among the firms surveyed in December, the number planning to increase capital outlays during the first half of 2007 barely exceeded the number planning to reduce capital expenditures. Retail Most of the retailers contacted for this report indicated that sales during the holiday shopping period were only slightly above sales during the same period in the previous year. Sales of jewelry and consumer electronics were relatively strong, but sales of most other lines of merchandise were below retailers' expectations. Sales of outerwear and other clothing were particularly soft. Merchants said unseasonably warm weather discouraged sales of winter apparel. Discounting was widespread during December, although most store executives said the price reductions made before the holidays had been planned in advance. Further price reductions, primarily for apparel, have been taken since the holidays. Looking ahead, retailers generally expect modest, steady growth in sales during the first quarter, although some believe sales growth might weaken through the winter. Auto sales in the region continued to be sluggish in December. Year-to-year sales comparisons were again better for foreign makes than for domestic makes, although some import dealers noted an easing in growth. Inventories remained above desired levels for many dealers but were gradually being worked down. Auto dealers in the region expect sales to remain slow through the winter. Finance The volume of loans outstanding at Third District banks rose moderately in December, according to commercial bank lending officers contacted for this report. Commercial and industrial lending increased for most banks. Credit card lending expanded, with a seasonal acceleration in growth. Growth in other types of personal lending slowed. Demand for residential mortgages and home equity loans continued to soften. Bankers in the District expect business and consumer lending to increase modestly in the months ahead, but they say the outlook for residential mortgage lending is uncertain. Some bankers indicated that mortgage demand appeared to be firming in their market areas, but other bankers said it remained weak. Investment companies in the Third District reported strong cash inflows as 2006 came to a close. Executives at these companies said the recent performance of equity markets had stimulated interest in stock funds among individual investors. They also noted that there has been rising demand for a variety of investment vehicles appropriate for retired individuals and those nearing retirement. Services Most of the Third District service firms contacted in December reported that activity was rising steadily. Business services firms generally indicated that work done for existing client firms was growing and that they were gaining new clients. Information technology firms generally reported continuing gains. Trucking firms, however, reported that growth had slowed in the final quarter of the year. Employment agencies and temporary help firms reported that, on the whole, demand for workers has been rising, although hiring plans have moderated in some sectors--notably, construction and government--and in some parts of the District. On balance, service-sector firms expect business to continue to advance at a steady rate in the months ahead. Prices and Wages Business firms in the Third District noted increases in the costs of raw materials and other inputs in December, although reports of price increases were not as widespread as they were earlier in the fall. Manufacturers noted increases in prices for chemicals, metals, and energy. Looking ahead, manufacturers expect cost increases for energy, raw materials, and intermediate goods, but they anticipate somewhat smaller increases in 2007 than in 2006. Firms in other industries expect input costs to remain on the rise at about the current pace. Firms reporting on employment costs in December noted a continuing trend of moderate wage increases but also large increases in benefit costs, especially health care. Many firms have recently taken steps to restrain the rate of increase in benefit costs. Among the measures implemented have been eliminating defined-benefit pension plans and requiring greater contributions toward health-care costs from employees. Return to top New York Cleveland