Higher oil and energy prices have combined with falling demand and stagnating prices to make life tough for small and medium-sized manufacturers.

Higher oil and energy prices have combined with falling demand and stagnating prices to make life tough for small and medium-sized manufacturers – and firms fear worse is yet to come.

Trading conditions have deteriorated in each quarter of 2005 and the latest CBI SME Trends Survey, shows that just one firm in eight (12 per cent) is more optimistic about the business outlook than in July. One in three (36 per cent) are more pessimistic.

In the three months to October, output fell for the third quarter in a row with just 20 per cent of small and medium-sized manufacturers increasing production compared to 35 per cent who saw it fall, a balance of minus 15 per cent. Two thirds of firms (63 per cent) are operating at less than full capacity.

Falling output, allied to higher oil and energy prices, pushed up average unit costs - a balance of 29 per cent of firms reported an increase in the last quarter. This was despite employers shedding staff - cutting the wage bill - for the fifth successive quarter.

More job losses are expected next quarter, especially among medium-sized manufacturers (those with 200-499 employees) with a balance of 17 per cent expecting to slim down the workforce compared to nine per cent for SME manufacturers as a whole.

At the same time, orders fell for the third successive quarter (a balance of 15 per cent indicating a decline) as the ripples of the consumer spending slowdown spread into other areas of the economy. Looking ahead, firms do not expect any improvement in the fourth quarter of 2005.

The weaknesses in company order books kept domestic prices virtually unchanged despite the rising production costs - the balance of two per cent who reported lower prices was much better than had been anticipated at the end of the second quarter when a balance of 12 per cent expected prices to fall.

This economic climate has led firms to cut back on capital expenditure plans. A balance of 23 per cent plan less investment in buildings compared to the previous 12 months while 18 per cent expect to invest less in plant and machinery. Uncertainty about demand and inadequate net return on the investment were cited as the two biggest reasons for this.

Turning to overseas markets, a balance of eight per cent of firms are more pessimistic about the prospects for export orders in the coming twelve months compared with July; the figure is slightly higher for medium-sized manufacturers (a balance of 14 per cent). The volume of export orders fell in the three months to October (a balance of 12 per cent) while average export prices - seen as the most likely inhibitor of orders - remained flat.

Hugh Morgan-Williams, Chairman of the CBI's SME Council, said: "Small and medium-sized manufacturers are a good barometer of future economic progress. They are the first to feel the effects of an ill wind and the last to recover. "

"Higher production costs as a result of rising charges for energy, oil and raw materials, coupled with stagnant output prices mean that smaller manufacturers are being squeezed at both ends. "

"As the consumer spending slowdown filters into other areas of the economy SME manufacturers have now experienced three consecutive quarters of falling output and are technically in recession. Worryingly, few firms are forecasting any signs of recovery while one in three are more pessimistic about the coming twelve months than in the summer."

The survey was conducted between September 22 2005 and October 13 2005. The number of companies who responded was 654. The quarterly survey has been running since 1988.