Slowing orders and rising costs are dampening the spirits of small manufacturers, the CBI has said.
According to its latest SME trends survey, domestic order volumes fell over the past three months when firms had expected them to rise.
This contributed to a heavier than expected rate of job losses and the prediction that the next three months will be even worst for medium-sized firms.
Small firms have also continued to underestimate cost increases, with average unit costs rising significantly in the past quarter.
Optimism about the general business situation declined slightly over the last quarter, disappointing a more positive outlook in the sector reported in the last quarter.
Business optimism among SMEs fell from an upbeat four per cent balance in July to minus four per cent, breaking down into balances of minus eight per cent for medium-sized firms and minus three per cent for small firms.
Other variations include total orders which split into a balance of minus one per cent for small firms and a balance of plus five per cent for medium-sized firms. And looking ahead, small firms predict a stabilisation in numbers employed, while medium-sized firms forecast a significant decrease (-17 per cent).
Accordingly, investment plans for buildings, plant and machinery have continued to be scaled back, but at a rate below the trend of recent years.
Steve Sharratt, chairman of the CBI's SME Council, said: "Optimism in the first half of the year saw firms hoping for growth in orders, but the sector has faced some tougher times, and things have turned out differently.
"A fall in demand and optimism coupled with further cost rises all place a question mark over the green shoots of recovery that we saw earlier this year. On a more positive note, export orders increased slightly and there is continued optimism for export prospects in the year ahead."
Despite the poorer than expected quarter, total orders were flat for SMEs, compared with a modest fall for manufacturers as a whole, which the CBI said reflected a more positive picture for exports.