October 15, 2003 Federal Reserve Districts Twelfth District--San Francisco

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Reports from Twelfth District contacts indicated some further pickup in economic growth in September. Despite continued increases in demand, many respondents indicated that strong competitive pressures continued to hold down prices and that productivity gains continued to keep hiring at bay. Retailers reported that sales continued to improve and service providers noted a further pickup in the demand for travel, software, and media services. Reports indicated that overall manufacturing activity continued to rise; orders strengthened for manufacturers of semiconductors, apparel, and lumber and wood products. Conditions for District agricultural and resource-related products were robust in recent weeks. Respondents indicated that the demand for homes remained strong, while the demand for commercial real estate remained sluggish. Banking contacts reported an increase in business loan originations in several District markets; however, mortgage refinancing activity continued to contract in recent weeks. Prices and Wages Most District respondents reported very little upward movement in prices. However, there were some exceptions. Energy prices were mixed, with gasoline prices falling but with residential electricity and natural gas prices increasing modestly. Several contacts noted that prices for lumber and other housing materials have shot up in response to strong demand from the Iraqi rebuilding efforts. Finally, health care costs appear to be rising rapidly. Although demand for many goods and services have increased in the District, employment conditions have continued to languish. A majority of District respondents reported no immediate plans to increase hiring, although some are optimistic that they will start hiring in a couple of quarters. For instance, District retailers, service providers, and banks have relied heavily on employee overtime and improved efficiency to meet increased demand. District manufacturers have used productivity gains and increased outsourcing to meet demand. In agriculture, producers have replaced some workers with machines for harvesting. Retail Trade and Services District retailers generally reported improved sales in September and early October. Back-to-school sales reportedly were strong, and department stores placed new orders to manufacturers after working off inventories of old merchandise in recent weeks. Automobile sales slipped some in September but remain at a high level; demand for some domestic brands came in below expectations given the generous financing available, but demand for foreign brands appeared to remain strong. Demand in the District for other services strengthened further in September, particularly for IT and media services. Respondents indicated that this could be explained partly by a pickup in demand for efficiency-enhancing technologies. Also, contacts reported a pickup in demand in food and restaurant industries. Conditions in the District's travel and tourism sectors improved further in September and early October. In Hawaii, international visitor counts have begun to increase after having been battered by fear of SARS and the war. Domestic visitor counts continued to be strong. Hotel occupancy rates have inched up in several District markets. On the down side, convention bookings have yet to pick up in Utah, and several airlines continue to face excess capacity. Manufacturing Manufacturing activity strengthened overall in September. Semiconductor producers reported a further pickup in demand for microprocessors, DRAM, and flash memory. As a result, capacity utilization in high-end fabrication plants is high and inventories are well balanced. Contacts also noted an increase in demand for storage devices. Demand conditions remained stable in biotech industries, and a rise in venture capital investment bodes well for biotech startups. Consistent with the pickup in apparel sales, clothing manufacturers reported a more positive demand outlook, although there continues to be a shift from producing apparel domestically to overseas. Demand for lumber and particleboard has increased, reflecting a surge in demand for projects in Iraq and continued strength in housing markets. On the downside, makers of telecommunications equipment and commercial aircraft continued to face overcapacity and weak orders and sales. Demand for machine tools and basic metals softened slightly relative to robust activity during the last survey period. Agriculture and Resource-related Industries Demand for most agricultural and resource-related products grew in the most recent survey period. Yields of fruits, vegetables, and nuts were high and inventories were near desired levels. Demand for District livestock, notably cattle, was strong, partly as a result of diverted demand from potentially diseased Canadian beef. Overproduction in the wine industry has led to excess inventories and downward pressure on prices. Prices for other agricultural goods remained stable and export activity continued to show strength for most markets. Real Estate and Construction Conditions in District real estate remained mixed, with commercial real estate markets still in a slump and residential markets still solid. Sales of new and existing homes remained robust, especially in Hawaii, Southern California, and some parts of Arizona. Elsewhere, there were some reports of moderation in home sales, although sales and prices generally were up from a year ago. On the commercial side, vacancy rates remained high but little-changed from the last survey period or from a year-ago. Respondents indicated that rental rates probably will stay at low levels for the time being, as landlords make concessions to increase occupancy. Financial Institutions District financial institutions generally experienced increased demand in the most recent survey period. Demand for business loans strengthened in recent weeks, while fierce competition for quality loans continued to put pressure on margins. Several bank contacts noted an acceleration of deposit inflows from businesses, which may signal improvements in general economic conditions. Loan growth was particularly strong in Southern California and Hawaii, consistent with robust economic activity there. Mortgage refinance activity declined further across the District, with no signs of pickup despite a slight decrease in interest rates during the survey period. Origination of new mortgages for home purchases remained strong, although District bank contacts observed signs of moderation in some markets. 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