June 13, 2007 Federal Reserve Districts Third District--Philadelphia

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The Third District experienced improved economic conditions in May, and the pace of growth was somewhat faster than in recent months. Manufacturers, on balance, reported increases in shipments and new orders, although activity among manufacturers dependent on the residential construction industry was slower. Retailers experienced different conditions depending on the market segment they serve. Sales of high-end goods increased significantly, while sales of other merchandise remained flat or increased only marginally. Auto sales have increased over the past few months, but they remain below averages in recent years. Bank lending rose at a moderate pace, with commercial and industrial lending showing the most strength. Activity in the commercial real estate sector has been relatively strong, but there has been no pickup in the residential sector. Firms commenting on labor costs generally reported steadily increasing wages, but there has been more cost pressure from nonwage benefits. Firms also reported significant price increases for raw materials and energy. Third District firms generally see business activity expanding in the second half of 2007. Manufacturers plan increased capital spending and expect more demand for their products in the months ahead. Retailers expect sales to continue to increase at their current rate. Auto dealers do not expect much change in the pace of car sales. Bankers anticipate a continuation of the steady increase in loan volume. Manufacturing Third District manufacturers reported increases in shipments and new orders in May. The increases were moderate, but they were the highest net increases since the beginning of the year. About one-third of the manufacturers contacted reported that current demand is greater than what they had expected at the beginning of the year, and only about one-quarter reported that demand is lower than what they had expected. Also, considerably more firms have increased their capital spending plans since the beginning of the year than have decreased them. Firms producing capital goods, such as electrical machinery and industrial equipment, generally reported increased activity in May, and they expect stronger activity over the next six months. On the other hand, those manufacturing firms whose business is related to residential construction reported slower activity. Over 40 percent of the manufacturing firms contacted for this report expect an increase in new orders, shipments, and overall activity in the second half of the year, and about a third expect activity to remain at its current level. Very few expect a decline in activity. Overall, manufacturers were more positive in this report than they were in their last report. Retail Retailers in the Third District reported varying rates of growth depending on the segment of the market they serve. Sellers of luxury items, excluding jewelry, enjoyed double-digit growth on a year-over-year basis, while the growth rate for most other items was significantly slower. Low-end merchants experienced little to no growth. Malls reported less traffic but higher average purchases. Most store executives reported no major changes to their inventories, and they expect sales growth to continue at around the current rate. Contacts report that overall auto sales have picked up somewhat in the last few months relative to the slow pace of January and February. Sales are still at relatively low levels, however. In general, dealers do not expect any significant pickup in sales in the near term, and they believe the recent string of dealer closings and consolidations will continue through the rest of the year. Finance Outstanding loan volumes increased at a steady pace in May, according to bankers in the Third District. Commercial and industrial lending remains strong, and 2007 is expected to be an above-average year for commercial lending. Buyout activity was cited by several lenders as an important reason for the increased borrowing by businesses, but borrowing for capital expenditures also contributed to the strength. Consumer lending has remained steady. Credit card delinquencies are stable, and payment rates on consumer credit are holding up. Residential lending is flat or down from last year. However, there is some regional variation; contacts report that residential lending in the Philadelphia suburbs is up relative to the same period last year. Overall, mortgage delinquency rates are holding steady. Some firms do not expect a pickup in residential lending to begin until sometime in 2008. Real Estate and Construction Commercial real estate firms report that office vacancy rates in the region have declined significantly over the past several months, and in response, landlords have asked for higher rental rates. The amount of leased space has increased in most markets in the region, and commercial real estate contacts expect this trend to continue. Construction is up across the region, although contacts caution that stricter scrutiny by rating agencies may have a dampening effect on future investment. Industrial real estate firms report that overall demand for industrial space remains strong. Vacancy rates are near record lows in some markets, and rental rates continue to rise, particularly for warehouse space, for which rents are at all-time highs. In contrast to the improving picture in commercial real estate, residential real estate firms report that there has been no improvement in the housing market since they were last contacted. Firms reported a normal seasonal increase in "traffic," or potential customers, early this spring, but this did not result in the normal seasonal increase in home purchases. Though residential construction and sales are generally slow, realtors did report that the market for homes selling below $300,000 is outperforming the market for all higher price ranges. The inventory of unsold homes is expanding, but not as quickly as it did last year. Average selling prices are basically unchanged from 2006. So far this year, the average number of days on the market has risen, but not to the highs experienced in earlier housing downturns. Realtors suggest that the correction in the housing market may result in a prolonged period of house prices rising more slowly than inflation, if at all. Prices and Wages Firms characterized wages as increasing at a steady pace. Employee benefits are currently exerting more pressure on costs than wages. Some businesses are providing employees with new nonwage benefits, such as gasoline cards. Some firms also noted an increase in the cost of providing employee health care. Among their other costs, several firms reported increased prices for raw materials as a significant issue. Firms continue to report higher energy-related costs, especially the cost of electricity. Almost four in 10 manufacturing firms reported increases in the prices paid for inputs and few reported any decreases. Return to top New York Cleveland