The gap between input costs and output prices continues to widen for the SME manufacturing sector and growth faltered to its lowest level since Q2 2003, according to the 'PKF SME Index', a quarterly survey of 800 SMEs operating in the manufacturing, construction and service sectors.

Although the manufacturing sector recorded its 12th consecutive quarter of increased output at 52.9 (where scores above 50 indicate a rise on the previous quarter), there is some evidence that growth is faltering as the sector continues to be badly affected by the 'China effect'; the continuing shortages of commodity raw materials; and the escalation of prices for steel, chemicals, oil and plastics.

Respondents are also concerned that prices will continue to rise in 2005.

While SME manufacturers are increasingly passing on these increased costs to their customers (output prices are up from 55.9 in Q3 to 59.7 in Q4), they cannot close the widening gap between what they have to pay and what they can charge. This is now at an all time high of 14.6 - up from 13.4 in Q3.

Employment within the sector is now finely balanced (50.0) with some employers continuing to recruit to meet increased production requirements while others are not replacing leavers and laying off seasonal labour.

David Mellor, partner at PKF, commenting on the SME Index findings, said: "The most worrying factor for SME manufacturers is that they have no control over their input costs and these are only going in one direction: up. The widening gap between what they have to pay for raw materials and the prices that they can charge their customers will increasingly erode their profitability or competitiveness, as is evidenced by several respondents who are already losing business to the Far East."

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