Small business confidence has slipped downward in the second quarter after a strong recovery at the start of the year, with FSB's Small Business Index (SBI) headline confidence measure falling to -14.2 points in Q2 2023, down from -2.8 points in Q1.

The decline reflects the downbeat economic conditions small businesses had to navigate over the quarter, with stickier-than-expected inflation, while two base rate hikes added pressure to index-linked debt repayments.

Q2's result is, however, more positive than the same quarter in 2022, when confidence plummeted to -24.7 points as energy prices surged in the immediate aftermath of Russia's invasion of Ukraine and inflation climbed steeply, sparking the first wave of the cost of doing business crisis.

There were strong sectoral differences in confidence, with accommodation and food services falling by 18.1 points to reach -35.8 points, while wholesale and retail tumbled by 12.6 points to reach -37.8 points.

Manufacturing businesses were more or less in line with the all-sector confidence reading, at -14.5, almost exactly the same reading registered in Q1 (-14.4), while information and communication fell by 4.9 points to hit -19.6. Professional, scientific and technical activities, meanwhile, was the only major sector to reach positive territory, at 7.8 points, down 7.1 points from the first quarter.

Revenues over the second quarter among small firms were in line with the previous quarter, with one in three small businesses reporting that they increased (33%, compared with 34% in Q1), and two in five reporting that they decreased (41%, unchanged from Q1).

However, looking ahead, small firms' revenue expectations have dampened, with only a third in Q2 (32%) expecting to see sales rise in the next three months compared to two in five in Q1 (39%), while a third (36%) expect to see a drop in sales, compared to a quarter in Q1 (26%).

The medium-term outlook was slightly rosier, with half of small firms anticipating growth over the next 12 months (51%), up from 46% in the first quarter. 

Employment numbers shrank as more small firms saw labour costs increase in Q2. One in seven small firms said their employee numbers declined over Q2 (14%, up from 12% in Q1), while one in eight said their employee numbers rose (12%, unchanged from Q1).

Exports improved compared with the previous quarter, with the number of small firms who export reporting an increase in volumes (33%) notably higher than in Q1 (22%), while the proportion reporting a decline in exports (36%) was lower than in the first quarter (40%).

Rising costs were an issue for the overwhelming majority of small firms, with 85% saying they had risen compared with the same period in 2022. 

Martin McTague, FSB's national chair, said: "Although the upturn in small firms' confidence from the first quarter didn't carry over into the second quarter of the year, the message from our research is that small firms' confidence in the future is looking rosier. Over half of all small firms expect to grow over the next year, for example.

"There are undoubtedly challenges ahead. Small firms are already feeling the impact of rate rises on their margins, and through lower consumer demand, and further increases will undermine the prospects of a recovery in confidence. Small businesses are very alive to the danger that interest rate rises will overshoot the level needed to curb inflation, and will instead act as a drag on economic expansion.

"Amid the rate rises and sticky inflation of the second quarter, and with economic growth underwhelming at best, it's disappointing but perhaps not surprising that the momentum from the first three months of the year petered out somewhat - but small firms are survivors, and there are positive signs in our findings.

"The proportion of small firms saying that their cost of doing business was higher than in the same period last year has eased back slightly from last quarter's record high, which resonates with the most recent inflation figures, and offers a small sign of hope that inflation may finally be on its way to being tamed.

"It is also very welcome to see energy and fuel costs falling in the rankings of small firms' most-cited barriers to growth. 

"Given the right conditions for growth, small firms have the potential to power a groundswell of economic activity. With the domestic economy the biggest perceived barrier to growth, however, they are in something of a catch-22 situation.

"The Government should get ahead of the curve, and take the summer to plan a programme for enabling small firms to grow and invest; tackling late payment in the official response to the recent late payment consultation would forge a path to an environment where late payments are all but eliminated.

"Taking concrete action on late payment would help to unlock confidence in the third quarter, especially with the end of the rises in the base rate perhaps finally in view."