September 10, 1975
Our directors report a growing concern over price increases. Inflationary expectations appear to have increased as a result of rises in fuel and food costs. Interest rates are also on the rise in spite of lagging demand for loans. Consumer spending is picking up slowly but construction activity remains depressed.
Consumer spending is currently being affected strongly by the prospect of higher food and fuel costs. For example, it has speeded up conversion to small cars which signals awareness of the need to conserve, and a willingness to adapt to lower cost substitutes. The high current rate of consumer loan delinquencies as well as high interest rates will deter maintaining expenditures through borrowing, but credit demand will increase somewhat, in part because of higher prices. Growth in retail sales, therefore, is expected to be slow over the next six months.
Many of our large manufacturers on the West Coast expect shortages of fuel oil and natural gas this winter and contingency planning is in effect. No inventory build-up is being observed and operation rates continue to be closely geared to the pace of incoming orders. A sudden cutback in fuel availability would translate into a decline in final sales almost immediately. Research into substitute sources of energy is being emphasized. One large lumber manufacturer reports that his firm is already converting its firing systems from natural gas to wood fuel.
In very few cases is the existence of unused capacity dampening the passthrough of increased costs. When questioned about price increases, a leading manufacturer of aluminum responded that current low profit margins could not justify further capital spending as long as costs continued to escalate without offsetting productivity increases. He anticipates a return to double-digit inflation in the "not-too-distant" future. Directors are worried about higher interest rates and the reimposition of price controls. Most believe, however, that the inflationary momentum will not be sufficient to stop the recovery currently underway although there appears to be less confidence today than was apparent two months ago.
Bank of America expects that the following specific forces are likely to place upward pressure on wholesale and consumer prices over the next six to nine months:
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higher than originally anticipated growth in aggregate demand over the period
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lower than historical post-recession productivity increases, at least initially;
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an increase in the price per barrel of oil due to a combination of a price increase by OPEC and partial or complete decontrol of domestic old oil prices;
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a continuation of food price increases for the remainder of this year;
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a continuation of relatively high wage and fringe benefit settlements;
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increased importation of high priced raw materials; and
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increased cost pressures directly related to purchases of pollution control equipment in a large number of industries.
The construction industry continues to show little sign of a strong recovery. Some nonresidential projects have been cancelled or stretched out and state governments have placed tight lids on expansion projects. Residential building too is almost at a standstill according to our directors, with little hope of a major turnaround in sight over the near future.
The expected increase in food prices stems partly from the fact that agriculture uses a large amount of fuel and that many fertilizers are derived from natural gases and other petroleum base products. The increased return to farmers from higher prices is expected to be wiped out by higher costs. In the District's dairy farming operations, higher grain feed costs and energy prices will further aggravate the adverse price relationships which have held dairy farming in a depressed condition for more than a year. Low plantings of potatoes elsewhere in the United States has resulted in a shortage with high prices which should benefit growers in Washington where output is normal.
Large commercial loan activity continues very quiet and demand deposits related to usage of money are down compared with a year ago.