Soaring raw material costs have been blamed for the worst level of profitability among manufacturing firms since the start of 2003.
The rate of return enjoyed by the sector - expressed as a ratio of operating surpluses compared to capital employed - was 6.1 per cent in the fourth quarter of 2004, against 7.1 per cent in the previous three months.
The figure was the poorest for seven quarters and came despite output levels improving by 0.2 per cent.
National Statistics said the sector achieved 6.9 per cent across 2004 - down slightly on 2003 and the sixth annual fall in the last seven years.
Steve Radley, chief economist at manufacturers' union EEF, said: "The figures show fatter order-books, for manufacturers, have not been matched by better margins which have become ever thinner over the past year.
"Profits have been squeezed by rising global competition and increasing costs, both of which show no sign of easing."
Overall, the rate of profitability for private, non-financial companies was 13.4 per cent in the last three months of 2004, against 13.5 per cent in the third quarter.
The rate of return for the services sector was also lower, down to 15.1 per cent from 15.5 per cent three months earlier and leaving the 2004 average at 15.8 per cent.
Even though production levels picked up, margins at manufacturing firms have suffered due to the soaring cost of oil - currently at $57 dollars a barrel in New York - and the weakness of the US dollar.
Nevertheless the economy is growing at a healthy pace.
Economic growth of about 2.9 per cent is expected in the second quarter of 2005, just short of the Treasury's 3-3.5 per cent target, according to BDO Stoy Hayward's latest Business Trends Report.
The report showed business optimism fell last month, which BDO said was partly due to the widely expected General Election - set to be announced today - drawing closer. A slowdown in house prices was likely to increase consumer caution and affect an already flagging retail industry.
BDO said it believed there would be two more interest rate rises before the end of the year, taking the figure to 5.25 per cent.
And after a disappointing start to the year, the financial services industry is now more optimistic about the future, according to the latest survey of sector by the CBI and accountants Pricewaterhouse-Coopers.
Business volumes are expected to grow at the fastest rate for a year and employment expectations are the strongest since the survey began in 1989.
Fund managers, banks and building societies recorded the biggest rises in optimism while general insurers and finance houses were the only sectors less optimistic than three months ago.
However, 30 per cent of companies said business volumes were down and 28 said they were up.
The balance of minus two per cent suggests that business remained flat over the past three months. But a balance of plus 23 per cent of firms expect an increase in volumes over the next three months, the strongest expectation since March last year.
Despite employers' gloomy predictions of job cuts, the numbers employed in financial services barely changed over the last quarter with roughly the same number of firms saying they were employing more people as saying they were employing fewer.
Looking ahead, 53 per cent of companies expect employment to be up over the next three months while only five per cent expected it to go down.
David Waller, chairman of PricewaterhouseCoopers Midlands, said: "The industry is now confident of an upturn in business volumes particularly from sales of savings and investment products."
Profits growth was weaker in the first quarter of 2005 and is expected to weaken further.
Fund managers, and finance houses saw the strongest growth in business volumes over the last quarter. Building societies and general insurers recorded the biggest falls.