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Luxuries re-evaluated as budgets tighten

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Feb 14, 2008

Luxury hotel stays, sport-utility vehicles and other trappings of upwardly mobile Americans might be among the first casualties of a US recession as consumers and businesses alike look to rein in spending.

For purveyors of those goods and services, from American Airlines and Starwood Hotels & Resorts Worldwide to Detroit’s carmakers, 2008 might the first of several lean years.

While many companies have yet to see a sharp drop-off in demand, they are nevertheless bracing for that eventuality as the world’s largest economy slows.

Jim Farley, Ford Motor’s marketing chief, said: “It’s not going to get easier, at least for a while.”

Emboldened by the escalating value of their homes, many US consumers spent freely and consistently. Now that falling real estate prices and stricter lending standards have made it harder to borrow, Americans’ spending habits are likely to change, too.

John Schmitt, senior economist at the Center for Economic and Policy Research in Washington, said: “American consumers have been living off their houses for the last six to seven years.

“Any area of economy heavily dependent on consumption by middle and upper-middle income people will be very vulnerable, even more so if there’s an element of discretion,” he said.

Car and light truck sales slipped to an annual rate of about 15.2m units last month from 16.7m a year ago.

Toyota, Ford, Chrysler, Honda and Nissan all posted lower January sales. General Motors, the industry’s lone bright spot, showed an increase thanks to new models.

Demand for new vehicles was at the lowest level last year since 1998, and many analysts and manufacturers predict sales will slide further in 2008.

Alan Mulally, Ford’s chief executive, has said that the carmaker will cut North American vehicle production by however much is needed to meet its goal of returning to profitability next year.

“Every month, we’re going to look at the market and see what level demand is,” said Mr Mulally.

Global Insight, a consultancy, estimates that Detroit will pare output to 8.8m units this year from 9.5m in 2007, a reduction equivalent to about four assembly plants. The cuts are likely to be deeper if the economy slips into recession.

Airlines are also retrenching. Many of the biggest carriers have cut plans to expand this year, especially on routes that connect two US cities.

Some carriers, including American, plan to trim domestic capacity.

Nicole Crain, a visiting professor of economics at Lafayette College, said: “Every time we go into recession, it hits the airlines. Leisure travel is discretionary.”

Fuller flights and higher fares helped airlines deliver a second straight annual profit last year – no minor achievement when it is considered that carriers have lost money about a third of the time since the US industry’s deregulation in 1978.

Giovanni Bisignani, chief executive of the International Air Transport Association, said demand for air travel has probably peaked.

“There will be no encore performance in 2008,” Mr Bisignani said. “Oil prices are higher than ever. Economic uncertainty accompanying the US credit crunch is broadening. And the slower growth for passenger demand in December sets the trend for the coming months.”

A drop-off in demand for air travel would put even more pressure on airlines’ profits if it is not accompanied by a decrease in fuel costs.

When aircraft fly with fewer passengers, the carriers cannot pass through fare increases that would have offset part of their high fuel bill.

Or, as Gerard Arpey, American’s chief executive, put it last month after his company reported a fourth-quarter loss: “As is always the case in this industry, there are many challenges facing our airline.”

Hotel operators might face many of the same problems even if, as many of the big airlines noted, demand remained healthy in the first six weeks of this year.

Starwood, which owns the Sheraton, W and Westin chains, cut its 2008 forecast last month to reflect “uncertainty surrounding the US economic environment and its impact on travel patterns”.

Mr Schmitt said: “A lot of people will be making decisions to not go on expensive vacations, to not get a new car.

“You don’t have to lose your job for the unemployment rate to affect your consumption rates. You’re looking over your shoulder,” he added.

ft.com

Luxuries re-evaluated as budgets tighten
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