Increased costs and an erosion of competitiveness are damping down business optimism and employment prospects, according to a new survey by small firms lobby group Isme.

However, the quarterly survey says that there has been a significant increase in the numbers employed in comparison to this time last year.

The biggest increases in employment were in the distribution sector followed by services and retail.

"Indications are that the manufacturing sector, while only reporting a modest net increase, is showing signs of improvement after a number of years of reporting net losses," it says.

"Looking forward, employment prospects are not as positive as they were previously, with a net 18 per cent of companies anticipating an increase in employment in comparison to a net 30 per cent in the previous quarter, a substantial reduction."

However, the survey points out that "it should be noted employment prospects in the last 12 months were very optimistic compared to the previous there years".

Isme says the survey confirms that as in previous quarters, the cost environment continues to dominate, with labour costs again being identified as the biggest immediate concern for small firms.

"It is absolutely essential in order to achieve future growth within the sector that wage rates are not allowed to get out of control, as happened previously, resulting in Irish wage rates increasing at 2.5 times the rate in the rest of the EU, " the lobby group says.

It says this is unsustainable and if allowed, will seriously undermine competitiveness. "Wage moderation is now a prerequisite for sustaining and developing future economic activity," it says.

It calls the increases in production costs (30 per cent over the last three years) to be factored in when negotiating a new national wage agreement.