Small and medium-sized manufacturers saw their output grow in the last three months of 2007 on the back of strong overseas orders.

Firms are pessimistic about the present quarter, however, as the economic slowdown is expected to dampen demand while rising input costs bite into profit margins.

The snapshot of the sector has been revealed by the latest quarterly SME Trends survey by the CBI, the UK's biggest business organisation.

Looking back over the three months to January, a balance of +10 per cent of SME manufacturers said their output had grown, exceeding expectations in October.

The balance of firms reporting growth in export orders (+12 per cent) was the strongest since October 1995 (+13 per cent).

This underpinned the unexpectedly healthy total order figure (a balance of +10 per cent) as domestic demand remained fairly static.

This quarter, firms expect demand to slip slightly, with domestic orders anticipated to drop (a balance of -4 per cent) and overseas demand to flatten.

Four out of five firms (78 per cent) said a lack of orders is likely to limit output over the next three months. This is the highest since January 2006. Rising input costs have continued to add pressure to companies' profit margins.

A balance of +30 per cent of SME manufacturers reported costs had gone up over the past quarter, and a balance of +29 per cent expect them to rise again.

While firms were reluctant to respond with price rises over the course of 2007, however, a balance of +22 per cent expect to do so in the coming quarter.

This is the strongest since April 1995 (+30 per cent). Small firms underpin this figure (+27 per cent).

Increasing efficiency is still cited as the top reason for expected capital expenditure, and planned investment in product and process innovation is at its strongest level in a decade.

Small manufacturers expect employment to remain stable in spite of economic uncertainty ahead.

Although a balance of 12 per cent of medium-sized firms expect to cut jobs in the coming quarter, this is in line with the long term average.

Russel Griggs, Chairman of the CBI's SME Council, said that uncertainty about the future was growing across the sector despite the fact that smaller manufacturers enjoyed the best overseas demand in over twelve years last quarter.

He added that last week's interest rate cut would provide some relief.

"Firms, especially the smallest, are no longer able to absorb rising input costs and, even with fears of weakening demand, are now being forced to raise prices. This continued squeeze on profit margins means that product and process innovation is ever more important," Griggs said.

He added that significant concerns about the capital gains tax system over the last quarter of 2007 had not been allayed by the Government's adjustments to the reform.

“With the economy slowing across the UK and the wider world, confidence amongst SME manufacturers is low,” Griggs concluded.

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