June 14, 2006 Federal Reserve Districts Fourth District--Cleveland

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The District's economy continued expanding in late April and May, as it has throughout the year. Most manufacturers reported steady to increasing production in recent weeks. Retailers also reported better-than-anticipated increases in sales relative to this time a year ago. Demand for trucking and shipping services remained strong and broad-based. While commercial building continues to recover, homebuilding has slowed. Some of this slowdown is reflected in weaker consumer loan demand at District banks, though commercial borrowing continues to be steady. On hiring, more firms reported that they are looking to add workers, and contacts from the staffing-services industry said that some types of skilled workers remain in short supply. Nevertheless, outside of a few areas, there were no reports of any accumulating wage pressure. Nonlabor input-cost increases, however, were widely reported. Specifically, contacts cited increases in the prices for petroleum-based products, some building materials and metals, and natural gas. Attempts to recover these increases in costs varied by industry; in general, about half of the contacts from construction and manufacturing firms reported attempts to increase prices in response to cost changes, while reports of retailers' increasing their prices were few. Manufacturing Contacts at the District's durable goods facilities generally reported that production was above year-ago levels at the end of May. Most contacts, including those in the steel industry, expect this trend to continue into the summer months. One industry with weaker current and prospective production was autos: At District auto assembly plants, production fell notably from last year's levels. Regarding capital expenditures, responses were roughly evenly divided between those firms that planned to increase spending in the next six to twelve months and those that did not. In terms of hiring, half of respondents reported hiring in April and May, but only a quarter plan any additional hiring in the near future. Wage pressures are not a concern. Input costs, however, increased in late April and early May, notably for petroleum-based products and metals. A quarter of those reporting indicated that they successfully increased prices in response. Production at the District's nondurable producers improved in April and May but remains roughly the same as at this time last year. Several contacts reported an increase in new orders. Hiring and planned increases in capital spending were limited. Though nondurable good producers also reported price increases in energy-related items, most contacts reported that their overall input costs were stable. According to contacts, firms that attempted to increase their prices had more success passing price increases along to smaller customers than to larger customers. Retail District retailers generally reported improving sales trends through the six weeks ending in May. Specialty apparel retailers reported higher sales than at this time last year. Sales at the District's drug stores were also above last year's levels, though sales trends for these retailers were less than the national average. Lastly, department store sales were a bit below last year's levels, but better than anticipated. Some segments, however, did see a softening. Reports from the District's discounters indicated that their sales were slightly weaker than anticipated, though sales still grew relative to a year ago. Some of this weakness was attributed to increases in gasoline prices. Several contacts suggested that consumers were more value conscious than in the recent past and that consumers may have been trying to limit spending to necessities. Increases in gasoline prices also affected retailers through rising freight costs; nevertheless, retailers' prices remained relatively flat. Most auto dealerships reported sluggish sales in late April and early May, though sales of foreign nameplates fared significantly better than their domestic counterparts. In response, some manufacturers are attempting to spur sales with incentives. For instance, in early June, Ford announced a new incentive offer, wherein buyers would receive $1,000 for gasoline purchases. Construction New home sales were mixed in April and early May compared to the first quarter, with more contacts reporting declines than increases. Second-quarter sales for most builders have declined on a year-over-year basis. About a quarter of the builders indicated they have increased their base prices in the last few months to offset increases in materials costs. However, a slightly larger proportion increased their discounts or incentives. Sales over the next several months are expected to fall from last year's levels. Many contacts reported significant increases in plumbing and electrical costs due to the increase in copper prices. Most contacts said subcontractors are less busy and more available than usual, and several builders reported reducing their payrolls, possibly pointing to net reductions in the industry's overall employment levels. Almost all commercial contractors reported that business has tended to improve throughout 2006 and is better than at this time in 2005. Contractors are optimistic about the remainder of 2006. Building segments reportedly doing well include office construction, particularly for professional service and health care concerns, and public projects. Contacts reported rising materials costs, notably for copper, concrete, drywall, and petroleum-related products. As a result, almost all contractors are planning to increase prices sometime in the future. About half reported increasing staff sizes, some significantly. Subcontractors are also seeing an increase in work and are charging higher rates. Banking At District banks, commercial loan demand was steady while consumer loan demand was soft in late April and May. Home equity loans were up, while auto-loan demand continued to be weak. The mortgage market softened in May and is expected to remain this way for the remainder of 2006. Credit quality remained strong for both consumer and commercial customers. Core deposits changed little at most banks. At this time, most bankers expect 2006 to be a challenging year due to narrowing net-interest margins. Transportation Demand for trucking and shipping services remained strong through the six weeks ending May. Higher fuel costs concerned contacts, even though trucking companies have been able to maintain their surcharges. Carriers continued to report difficulty attracting and retaining drivers; however, few firms planned to increase wages. As previously reported, capital spending in the industry is strong, as firms attempt to purchase trucks that don't need to meet impending EPA guidelines. Return to top Philadelphia Richmond