Bleak surveys pose interest rate rise dilemma for Bank of England

• Number of profit warnings in first quarter up 50%
• Confidence lower than in recession, say finance chiefs

Britain's stagnating economy faces months of gloom after a series of business surveys showed profits down and confidence among industry bosses waning.

A report by the accountants Ernst & Young found that UK companies issued 50% more profit warnings in the first three months of the year compared to the fourth quarter of 2010 as a squeeze on household spending, soaring commodity prices and rising inflation eroded consumer and business spending.

The survey showed that UK listed firms issued 75 profit warnings in the first quarter of 2011, well up on the same period a year ago. Mass market retailers were the worst hit along with business support service firms, media and IT companies.

A quarter of firms that issued profit warnings blamed increasing costs and pricing pressures from a jump in oil prices to more than $125 a barrel and rising commodity costs.

E&Y said: "Although a third of companies cited last December's cold snap as a significant factor affecting their trading performance, the snow was a contributing rather than lead factor in many of these profit warnings. By the end of the quarter, squeezed consumer spending and rising commodity price concerns had moved to the fore."

The results follow reports last week showing the economy stagnated over the last six months. A dip in growth before Christmas following the heavy snowfall and a small bounce back in the first quarter cancelled each other out. Concerns that the first quarter bounceback may be smaller than expected were fuelled by figures from the construction industry showing it was especially weak, with few orders or building projects under way. The gloomy data has posed a dilemma for the Bank of England's monetary policy committee, which is under pressure to raise rates to combat rising inflation. Signs from industry that firms passing on rising raw material costs in the form of higher prices has added to concerns that inflation will continue rising beyond the summer.

The accountants BDO said its survey showed renewed vigour in some parts of the economy, but the renaissance was in its infancy and a rise in base rates could kill it off. Its latest business trends report found output and confidence grew in March but "growth prospects are not robust enough to withstand an interest rate rise".

It said: "The current rate of growth merely returns the UK economy to its position prior to the contraction of 0.5% in the fourth quarter of 2010, rather than heralding sustained economic recovery. In effect, a premature rise in interest rates could risk the fragile prospects of a return to trend growth."

BDO's employment index also improved, rising from 97.8 in February to 100.5 in March – reaching its highest level since September 2008. Yet the firm remained sceptical that it pointed to an underlying strength in the recovery, especially as the latest data shows that public sector employment, which fell by 39,000 in December on the previous three months, will fall further over the next year. BDO partner Peter Hemington said: "Although this month's data shows marked improvement, the recovery is still far from guaranteed. While it is unlikely that the UK will slip back into a technical recession, growth is far from robust and will be compromised if the MPC jumps the gun with a premature rate rise. We need to see at least four months' sustained growth before the MPC considers intervention.

A survey of finance directors by the accountants Deloitte showed confidence down to recession levels. It found the buoyant mood among finance directors as they entered 2010 has wilted.

Finance directors cited high levels of inflation and concerns about the effects of the government's spending cuts as strong reasons to be cautious. They attached a 29% probability to the chance of a double dip in the economy – up from 27% last quarter.

Where there are signs of growth, it is likely to be in the south-east, said high street bank Lloyds, adding to concerns that a two-speed recovery will be led by London and the home counties while other parts of the country are left behind.

Lloyds said the south-east topped the regional growth table, and posted its steepest rise in business activity for 3½ years. But even London's return to health could be undermined, the bank said."Recent global events and sharply rising input prices are causing concern among companies about the sustainability of this growth momentum. Regions outside London, particularly those with a greater share of manufacturing companies, are experiencing the strongest period of cost inflation since the record highs of 2008. This in turn has squeezed margins and added to uncertainty about the economic outlook, deterring further staff recruitment and constraining investment," it said.