The Confederation of British Industry (CBI) has warned UK small and medium sized businesses (SMBs) to expect domestic orders to drop over the next few months as spending tightens and costs rise.

Despite the fact manufacturers actually saw output grow in the final three months of 2007 – thanks in large part to strong overseas orders – a CBI survey has revealed that cost hikes and a dip in confidence among the business community is likely to put a dent in the next quarter.

It added that SMBs will struggle to absorb the shock if the economic downturn continues to bite.

CBI SME chairman Russel Griggs said: "Though smaller manufacturers enjoyed the best overseas demand in over 12 years last quarter, and last week's interest rate cut will provide some relief, uncertainty about the future is growing across the sector.

"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 added that the government's recent adjustments to the capital gains tax system had not gone far enough to allay SMBs' concerns.

However, it's not all doom and gloom for the manufacturing industry, where planned capital expenditure on product and process innovation is at its strongest level in a decade.

CBI's results can be viewed here. ®

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