July 25, 2007 Federal Reserve Districts Third District--Philadelphia

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Economic conditions improved in the Third District in June. On balance, manufacturers reported increases in new orders and particularly in shipments, although manufacturers of capital equipment saw reductions in both measures. Retailers experienced different conditions depending on the market segment they serve. Sales of high-end goods increased significantly, while sales of low-end merchandise remained flat or increased only marginally. Auto sales had increased over the past few months, while June saw significant declines with recovery expected in July. Overall bank lending rose only slightly, with residential and personal lending remaining flat and the commercial real estate sector seeing continued strong performance. Firms commenting on labor costs generally reported steadily increasing wages, but observations on nonwage benefits were mixed with some firms reporting acceleration and other reporting a slowdown in increases. Firms continued to report significant price increases for raw materials and energy. Third District firms generally see business activity expanding in the second half of 2007, although bankers are less optimistic than in previous reports. Manufacturers plan higher levels of capital spending and expect more demand for their products in the months ahead. Retailers generally expect sales to increase at their current rate and the outlook from auto dealers has improved despite the slowdown in June. Manufacturing Third District manufacturers reported increases in shipments and new orders in July. The increase in shipments was by far the largest in the last six months, with four in ten manufacturers reporting increases and only two in ten reporting decreases. Order backlogs grew for the first time in over a year. Capital spending plans picked up somewhat over the past two months, with increases scheduled in most manufacturing industries. Firms involved in the production of lumber, petroleum, rubber and metal products reported increased activity in July while firms producing capital goods generally saw slower activity. More than half the manufacturing firms contacted for this report expect an increase in new orders and shipments over the next six months, with only a few expecting decreases. Expectations for overall business activity are upbeat, with nearly half expecting increases. Retail Retailers in the Third District continue to report varying rates of growth depending on the segment of the market they serve, with overall sales quite strong in May followed by growth closer to trend in June. Sellers of luxury items continue to see growth in the double-digits on a year-over-year basis, while the growth rate for the upper-moderate segment remains robust. Moderate and low-end merchants experienced varying growth rates close to zero on average. Malls reported a continuation of the trend toward less traffic but higher average purchases. Some store executives reported decreases in inventories as anticipated, and they expect sales growth to continue at around the current rate. Contacts report that, while remaining at relatively low levels, second quarter auto sales were significantly higher than in the first quarter. June brought decreases in sales, particularly for domestic nameplates, but dealers expect July numbers to show a recovery. They point to the arrival of new incentives for domestics as contributing to their improved outlook. However, dealers continue to close and consolidate at a high rate. Finance The volume of outstanding loans at Third District banks rose slightly in the second quarter and in June, according to lending officers interviewed in July. The picture is mixed, however, and members of the banking industry were generally less optimistic than they were at the time of the previous report. Though commercial and industrial lending, which remain the primary growth driver for banks, edged up, personal lending remained about flat. Demand for residential mortgages also remained flat. Bankers noted that home equity borrowers almost exclusively sought fixed rate lines of credit, but that margins from the prevailing fixed rates are so low that there is little benefit to making the loans. Some bankers also reported that meeting lending targets for the year was no longer likely. On a more positive note, other bankers reported that, in commercial real estate, the region is performing strongly, with delinquencies at low levels. Credit card lending also seems to remain a positive for the industry, with delinquencies and charge-offs still below historic trend levels. Investment companies reported continuing strong cash inflows to both equity and fixed income funds and other investment products. In general, recent conditions do not seem to be as strong as they had been in the first quarter. It is, as yet, unclear whether or not this is the beginning of a trend or a temporary issue. Expectations were that downside risks for the industry are increasing rather than declining. Services Business services firms reported steady growth, with increased activity for existing client firms as well as work for new client firms, including significant increases in business from start-up and early-stage firms. Employment agencies and temporary help firms reported that demand for workers has been rising, and they expect the overall pace of hiring growth in the region to be around the same in the third quarter as it was in the second quarter. Service-sector firms generally expect business to continue to increase in the months ahead, and some anticipate a slight pickup in growth. Prices and Wages Business contacts noted recent increases in costs for some agricultural commodities. They expect a more general rise in prices for agricultural products in the future as demand grows for corn for ethanol and as the supply of other crops falls due to diversion of land to corn production. Firms continued to cite increased prices for raw materials and energy-related costs as a significant issue. Almost four in ten manufacturing firms reported increases in the prices paid for inputs and few reported any decreases, as in the previous report; in contrast, there was a rise in expectations for input cost increases over the next six months. Most of the firms reporting on employment costs in July noted a continuing trend of moderate wage increases. Some noted that the rate of increase in wages and benefit costs appeared to be accelerating somewhat; however, others reported a slowdown in benefit cost increases. Return to top New York Cleveland