June 14, 2006 Federal Reserve Districts Third District--Philadelphia

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Overall economic conditions in the Third District improved in May. Labor markets tightened. Manufacturing increased during the month, although the pace of growth eased. Retail sales of general merchandise rose, and the year-to-year gain improved compared with April; however, auto sales declined. Bank lending has been increasing, although demand for residential mortgages has softened. Residential real estate activity slowed, but commercial real estate markets continued to firm. Third District business contacts generally expect business activity in the region to continue to expand at a moderate rate, but they anticipate further slackening in auto sales and residential real estate. Manufacturers expect the rate of growth to pick up during the second half of the year. Retailers anticipate steady gains in the next few months, although for the longer term they are concerned that if interest rates and gasoline prices remain at current levels or increase, this will dampen consumer spending. Auto dealers expect sales to remain sluggish through the rest of the year. Banks anticipate a moderate increase in business and personal lending, but they forecast a further decline in mortgage lending for home purchases. Contacts in residential real estate expect home sales and construction to fall further this year. Contacts in commercial real estate foresee an increase in demand for office and industrial space, but they expect construction to ease. Manufacturing Manufacturing activity increased in May, but the pace of expansion slowed from April. Around one-half of the Third District manufacturing companies contacted for this report said that shipments and new orders in May were level with April; only a few more firms reported increases for the month than reported decreases. On balance, area manufacturers reported virtually no change in order backlogs, although delivery times rose slightly. Demand picked up in May for lumber and wood products, paper products, metals and metal products, and industrial equipment; demand softened for transportation equipment, industrial instruments, and non-metallic industrial materials. Overall, manufacturers expect the pace of growth to improve in the months ahead. Half the firms contacted in April expect their shipments and orders to increase during the next six months; about one-fourth expect decreases. On balance, capital spending plans among District manufacturers call for modest increases in expenditures. Retail Most of the retailers contacted for this report indicated that sales increased from April to May. Although the gains varied among stores, on balance it appeared that the year-over-year increase in May was somewhat stronger than the increase in April. Area merchants said warm weather prompted purchases of summer apparel and other seasonal merchandise. Third District retailers expect sales to grow at about the current rate into the summer months. However, they believe gains in consumer spending will eventually ease if higher gasoline prices and interest rates persist. Auto sales in the region declined in May, compared with April and with May of last year. Dealers said foreign models continue to have better year-to-year sales comparisons than domestic models, and that luxury car sales have been propped up by an increase in leasing. Inventories were held in check because dealers have limited orders to manufacturers. The consensus among auto dealers in the region is that sales will be sluggish for the rest of the year. Finance The volume of loans outstanding at Third District banks rose from April to May, according to commercial bank lending officers contacted for this report. Commercial and industrial lending increased for most banks. Consumer lending also rose, with gains in credit card lending and home equity loans. Demand for residential purchase mortgages continued to ease. Deposit interest rates were rising amid strong competition, but most of the banks surveyed for this report said their net interest margins have been steady. Bankers in the District expect continued growth in business and consumer lending in the months ahead but foresee further weakening in residential mortgage lending. Commercial bank loan officers contacted for this report generally indicated that credit quality remained good for both consumer and business loans. However, some bankers expect some borrowers to face repayment difficulties if interest rates continue to rise. Real Estate and Construction Commercial real estate firms reported that vacancy rates in the region's office markets have continued to decline in the past few months. Rents have shown little change, overall, moving up somewhat in some markets and edging down in others. Commercial real estate contacts expect further gradual tightening of the region's office markets this year if the local economy continues to expand at its current rate. However, they expect the supply of office space in the region to increase this year and next as buildings under construction are completed. Additionally, corporate consolidation is expected to result in some currently leased space coming on the market in the months ahead. Demand for industrial space in the region continued to grow, and there has been an increase in the construction of industrial buildings on both a speculative and build-to-suit basis. Residential real estate agents and homebuilders generally reported a slowing in sales in May, compared with the pace set earlier this year and with sales in May of last year. Real estate contacts noted that the number of existing homes for sale and the time they are on the market have continued to increase. Homebuilders and real estate agents expect sales this year to be lower than in 2005, and they expect price appreciation to slow significantly. Although home builders and real estate agents described the slowdown in sales as gradual in most parts of the region, they indicated that sales of homes in resort areas have declined sharply. Prices and Wages Business firms in the Third District reported continuing increases in the costs of raw materials and intermediate goods. Manufacturers continued to face price increases for lumber, metals, petroleum-based products, and chemicals. They also noted some shortages and delivery delays for metals and metal products, wood products, and electronic components. Retailers indicated that they have raised retail prices significantly for some goods with large plastic or metal content, although they have not implemented major price increases for most lines of merchandise. Construction firms reported continued high prices and delivery delays for some materials. In response to rising costs, some construction projects have been rebid or redesigned to reduce the amount of costly materials used. Some firms said their suppliers were including automatic price escalation in contracts to cover future increases in the cost of materials. Firms in all industries noted increases in delivery charges. Employers in a range of industries reported that labor markets remain tight, and college placement offices generally indicated that recruiting activity picked up this year compared with last year. Most area firms indicated that wage and salary increases implemented recently have been slightly greater than they were last year. Employers reported having greater difficulty filling positions requiring skilled labor and for some professional specialties, and they have raised salaries more for these workers than for others. Employers also noted an increase in quit rates as employees are finding higher-paid positions easier to obtain. In some parts of the region seasonal jobs have been difficult to fill, and wages for these jobs have increased significantly compared with a year ago. Return to top New York Cleveland