For the second consecutive quarter, small firms say they are planning to increase investment in plant and machinery over the coming year. These are their firmest investment intentions for a decade, and come as the highest proportion of firms since 1995 expect plant capacity to limit their output.

The small manufacturers report a pick-up in the growth of output and total orders, and plan to hire staff at the strongest rate for a decade. However, shortage of labour is a growing issue, with the highest proportion of respondents since 1989 saying that this is likely to limit their investments over the coming year.

"Labour shortage is an increasing constraint to expansion, and a lack of skilled labour is particularly likely to hamper small firms` ability to meet demand," comments Steve Sharratt, chairman of the CBI`s SME Council. "Unsurprisingly, planned investment in training and retraining has been increased during 2007 to help tackle this.

"SME firms are not complacent, and predict a tightening of profit margins in the coming quarter," Sharratt adds. "Nevertheless, SMEs see this increase in business as providing the opportunity to invest further in product and process innovation in order to enhance both competitiveness and productivity."

The SME manufacturers report that export orders have dipped recently for the first time this year, and the firms are now less optimistic about the export outlook for the year ahead. They cite prices as being the most significant factor limiting their sales abroad.

The smaller firms fared better over the past three months than the UK manufacturing sector as a whole, which saw the growth in orders fall back from April`s peak. The balance of SME firms seeing orders rise rather than fall, remained steady at 12%.

After a bumper spring, mid-sized manufacturers saw their growth slow sharply in the April-July quarter. The balance of firms reporting a growth in output fell from 33% to a just 6%. This made the medium-sized firms more apprehensive, and although employment was stable over the past three months, they now expect it to drop. Investments in buildings, plant and machinery are also likely to be scaled back.

The CBI SME Trends Survey is based on the responses from 535 manufacturing companies with fewer than 500 employees (with 449 of them having fewer than 200 staff). SME manufacturers account directly for 2.4m jobs in the UK - around 8% of total employment - and contribute £200bn to the UK economy.