March 3, 2004 Federal Reserve Districts Third District--Philadelphia

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Economic activity in the Third District expanded in February. Manufacturers reported increases in orders and shipments for the month. Retail sales of general merchandise rose in February compared with January and with February of last year. Auto and light truck sales were mostly steady for the month, but up on a year-over-year basis. Bank lending has been advancing moderately, with gains in business and residential mortgage lending but a decline in consumer loans outstanding. Commercial real estate markets in the region remain soft, with little change in vacancies but continuing declines in rental rates. Residential real estate construction and sales continued to be strong, moving up in February after cold, stormy weather interrupted sales and building activity in January. The outlook in the Third District business community is generally positive. Manufacturers forecast increases in shipments and orders during the next six months. Retailers anticipate a moderate increase in sales in the spring compared with a year ago. Bankers expect business and consumer lending to increase, but have mixed views on the course of residential mortgage activity. Commercial real estate companies expect the region's office markets to firm up slowly during the year. Residential real estate agents anticipate a nearly steady sales rate for most of this year, but builders have varying forecasts: some expect increases and some expect decreases in sales for the year as whole. Manufacturing Manufacturing activity remained on the rise in February, according to reports from Third District firms. One-third of the manufacturing companies contacted in February reported increased shipments compared with January, twice the number that reported decreases. Four out of 10 said their orders have increased compared with January while only around one in 10 reported decreases. On balance, order backlogs at area plants continued to edge up in February. Firms in nearly all of the major manufacturing sectors in the region generally indicated that business conditions were improving. Increases in demand were especially strong for firms producing industrial rubber and plastic products, electrical machinery, and a variety of metal products. Demand for products used in homebuilding remained strong, and demand for materials and products used to manufacture industrial equipment has increased. Although conditions were improving in most industry groups, there were some reports of slowing orders among makers of electronic instruments. Processors of poultry products indicated that the occurrence of avian flu in the region has negatively affected exports but has not had much impact on domestic demand. Manufacturing firms in the region reported generally rising prices in February, and the number of firms making such reports has increased in recent months. Among the goods frequently mentioned as rising in cost are natural gas, oil, scrap metal, steel, lumber, and various building materials. Looking ahead, the region's manufacturers anticipate further improvement in business conditions. More than half of the firms contacted for this report expect increases in shipments and orders, and only around one in 10 expect decreases during the next six months. Area manufacturing firms plan to add employees and extend working hours in the next six months, and, on balance, they are scheduling increases in capital spending. Although inventories have been flat, overall, among area firms, almost half plan to increase finished goods inventories in the next six months and around one-fourth plan to reduce inventories. Retail Third District retailers generally reported that sales moved up in February compared with January and with February of last year. The monthly gain was moderate, but the year-over-year increase was fairly strong because sales in February of last year were severely reduced by store closings during snowstorms. A brief spell of cold weather in late January helped stores move out winter apparel, and warming temperatures later in February boosted sales of spring clothing. Most of the stores contacted for this report also indicated that sales of Valentine's Day merchandise were up from last year. Retailers generally described inventories as satisfactory though they are still awaiting delivery of some spring merchandise. Third District retailers expect sales for the spring season to be moderately above the same period last year. Store executives said consumer confidence appears to be on the rise, although they noted that shoppers are still being selective and resisting impulse buying. Although retailers in the region believe economic conditions are improving, they noted that some national chains that are retrenching have closed stores in the region despite their profitability locally. Auto dealers reported generally steady sales in February at a pace somewhat higher than in February of last year. They cited favorable weather conditions this year compared to last for the year-to-year gain. Some dealers reported strong sales of new model vehicles and said they could sell more if the supply were greater. Local auto dealers believe the current relatively healthy sales rate will persist as long as manufacturers maintain their financial incentive programs. Finance Outstanding loan volume at Third District banks was moving up at a moderate pace in February, according to banks contacted for this report. Commercial and industrial loans were on the rise as business at area firms has been increasing. Residential real estate lending continued on an upward trend with gains in purchase mortgages despite some slowing in refinancings. Bankers generally indicated that consumer loan volume has moved down seasonally. Bankers in the District anticipate moderate growth in lending this year. They expect business lending to increase further as business conditions improve in more industrial sectors. Bankers generally see an upward trend in consumer lending as employment gains begin to solidify, but some expressed concern that consumer credit quality has been weakening. Bankers and other mortgage lenders expect a fairly steady rate of residential lending for purchase mortgages during the spring, although some anticipate a slowdown later in the year. Real Estate and Construction Commercial real estate firms in the Third District reported little change in market conditions in the past few months. The overall office vacancy rate rose slightly in suburban markets, but was steady in the Philadelphia central business district. For suburban markets as a whole the vacancy rate is estimated at 25 percent, with a great deal of variation from location to location. The vacancy rate in the Philadelphia central business district remains at nearly 13 percent. Throughout the region, effective rental rates have continued to decline. Many lease renewals are being negotiated and tenants have tended to sign for shorter terms and less space than they had done previously. Commercial real estate contacts say that owing to these new leases, as well as the capacity of many firms to expand within their currently leased space, vacancy rates will decline only gradually during 2004. Industrial building vacancy rates have been nearly steady, although rents have edged down. However, real estate contacts in the region said they have seen recent signs that demand for industrial space is firming as manufacturing and distribution activity has picked up. Residential real estate agents and homebuilders generally reported that sales have been rising in recent weeks, with a noticeable pickup after a series of winter storms passed through the region. Price appreciation appears to be steady. Real estate agents expect the pace of existing homes sales to continue near its current rate through most of this year. Builders have mixed views; some expect slight declines, others expect slight increases in sales this year. Shortages of land for development continue to constrain builders' ability to meet demand in some parts of the District. Return to top New York Cleveland