By Max Clarke

Smaller manufacturers saw production pick up in the three months to January, as domestic demand for UK-made goods improved, the CBI said today (Monday). But firms are facing strong cost pressures, which are now feeding through to higher domestic and exported goods prices.

The CBI’s latest SME Trends Survey reveals that 30% of the 366 respondents said the volume of output rose, and 17% reported a fall, giving a balance of +13%. That was slightly weaker than expected (+19%) but stronger than the balance of +9% recorded in the previous quarter.

Output was lifted by an improvement in domestic orders growth, with 28% of firms reporting a rise in volumes, and 20% a fall, giving a balance of +8%. That is the fastest increase since January 1997 (+11%). Export orders also rose modestly with 29% of SMEs reporting a rise, and 20% a fall. The resulting balance of+9% was down marginally on the previous quarter (+11%).

But intense cost pressures since early 2010 have weighed on profit margins, and average unit costs increased sharply again (+28%). This led to a noticeable rise in both average domestic prices (+6%) and average export prices (+9%).

In the next quarter, firms expect unit costs to increase again (+31%), and domestic prices are predicted to rise even more sharply; the expected balance (+24%) is the highest since July 2008 (+27%). Meanwhile, a balance of +33% of companies predict average export prices to head higher, the strongest expectation since January 1995 (+38%).

With domestic demand and output improving, a balance of +10% of firms increased the numbers they employ, the fastest rate of growth since April 1995 (+13%).

Looking to the coming quarter, firms expect production to rise again (+11%), with export orders expected to strengthen (+13%), but domestic orders are set to see a slightly slower increase (+4%).

Lucy Armstrong, Chairman of the CBI’s SME Council, said:

Manufacturing is one of the few bright spots in the economy and this survey underlines the important role of smaller firms in delivering growth and jobs.

“With domestic orders steadily improving and production rising, firms are increasing their headcount to keep up with demand.

“But smaller manufacturers are facing intense cost pressures and are being forced to pass these onto customers. Both domestic and export prices have already risen, and an even sharper increase is expected in the coming quarter.”

Looking at investment plans for the year ahead, firms plan to spend more on plant and machinery (+7%), product & process innovation (+13%) and training and re-training (+9%), with expanding capacity picking up noticeably as a motivation for planned spending. Labour shortage has risen as a factor likely to restrict investment, cited by the most firms since July 2008.

Optimism about the general business situation remained broadly unchanged (+3%) for the third successive survey, although optimism about export prospects for the year ahead has risen more substantially (+11%) compared to three months ago.