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Beige Book Report: San Francisco

August 2, 1988

Summary
The Twelfth District economy continues to expand at a healthy pace. The Business Sentiment survey reveals that expectations are somewhat more modest than in the last report, although most respondents continue to anticipate healthy economic growth. Auto sales are satisfactory, but retail sales growth remains sluggish. Manufacturing activity continues strong, with most respondents reporting inventories close to desired levels. The drought has not affected most western farmers, although profit margins on cattle are being squeezed by higher feed costs and lower beef prices. Demand for most forest products continues strong, but strikes at several Northwest mills are restricting supply. Construction and real estate activity continues mixed, with the coastal states reporting particularly strong demand for single-family homes. Respondents are about evenly divided between those who anticipate steady wage gains during the next year and those who expect wage increases to accelerate. Banks and thrifts report generally healthy activity.

Business Sentiment
Respondents to the Twelfth District Business Sentiment survey continue to expect GNP growth during the next year to be a little lower than 3 percent, with none anticipating a recession during that period. Compared with the previous survey, respondents are slightly less optimistic about economic growth, and somewhat more optimistic about inflation.

Consumer Spending
Auto sales continue at a satisfactory pace in most part of the Twelfth District. Inventories of most domestic models are at or below desired levels, but some respondents report that slow sales have increased inventories of imported cars to unsustainably high levels.

Growth of retail sales remains sluggish. One retail executive asserts that the sector is improving very slowly from its poor Spring. Another notes continued slow growth, but points out that retailers have been managing expenses and inventories very conservatively, and earnings therefore have held up reasonably well. Most respondents indicate that retail inventories are close to desired levels.

Manufacturing
Overall, manufacturing activity in the West is strong. Commercial aircraft and heavy equipment manufacturers note especially robust activity. Most information about the electronics industry suggests that it is benefiting from a surge in orders and sales, although one manufacturer of electronic components notes some weakening in recent weeks, and at least two sizable plants are slated to close.

Respondents indicate that overall inventory levels are either close to or somewhat below their desired levels. Lean inventories are reported for sectors that are experiencing strong demand, including some electronic components and exported products, as well as minerals, valves, and castings that are in short supply. A few respondents note high inventory levels, but these respondents also point out that some of the inventory accumulation is an attempt to ensure the availability of products for which demand is expected to be strong.

Agriculture and Resource Related Industries
The drought is not expected to cause problems for most western farmers, since most acreage in the West is irrigated and reservoirs hold sufficient supplies for this summer. Cattle ranchers, however, have range land that is providing insufficient nourishment, and feed costs have escalated substantially due to the drought. As a result, many are selling earlier than they otherwise would, to avoid paying the high feed costs. In the glutted marketplace, they are getting lower prices, and most anticipate significantly higher prices in several months as the glut is worked off.

The forest products industries continue to experience strong demand, from both overseas and domestic markets. Pulp and paper activity is particularly strong, and production is running at capacity. Nevertheless, inventories reportedly are low at both the user and manufacturer levels, so several firms plan to expand their production capacity. However, lumber production has been curtailed because of recent strikes at several mills.

Construction and Real Estate
Construction and real estate activity continue mixed in the Twelfth District. In the coastal states, the pace of residential building is healthy, particularly for single-family homes. In the Los Angeles and San Francisco regions, some areas with limited available space are seeing such frenzied home buying activity that home values have increased by as much as 25 percent during the past year. Activity in Idaho has improved modestly during the past few months.

In contrast, construction activity in Utah was so weak during the first five months of 1988 that it will take a remarkable rebound even to reach 1987's poor showing. Arizona is in somewhat better shape than Utah, but activity continues to languish there as well.

Wages and Salaries
Most respondents anticipate wage increases in the 4 to 5 percent range during the next year. Respondents are divided about evenly between those who expect wage and salary increases during the next twelve months to be unchanged from those of the past year, and those who anticipate some acceleration of wage hikes.

Most of those who anticipate steady wage gains argue that increases will be low due to pressures for keeping costs under control, expectations of weakening activity (as for defense contractors), or a trend toward tying individual compensation more closely to performance. Those who anticipate higher wages cite the pressures for wage increases that have resulted from recent high profits (as in timber), general improvements in economic activity (as in Boise), and difficulty attracting and retaining qualified workers.

While California is not experiencing labor shortages associated with immigration reform, some farmers in Idaho reportedly are paying day laborers substantially more than they did last year. Few respondents note wage increases associated with California's new $4.25 minimum wage, which went into effect on July 1. These increases occurred in such low-wage sectors as agriculture, restaurants, and hotels.

Financial Sector
Most western banks and thrifts report healthy conditions, reflecting the healthy regional economies in which they operate. Several bankers note particular strength in consumer lending, while a few cite commercial lending as the leading sector. Bankers in Oregon, Washington, and California report stiff competition for quality mortgage applications.