British Airways issued a profit warning yesterday after a collapse in its earnings during the first quarter of this financial year.

The airline said that its pre-tax profits had fallen by 88 per cent in the three months to June 30 because of rising fuel bills and the economic environment.

BA, which this week revealed that it was in merger talks with Iberia, of Spain, has lowered its full-year profit forecast from about £600million to just above break even. The airline has also reduced its revenue growth forecast from 4 per cent to 3 per cent to reflect weaker consumer demand.

The new profit target is a remarkable turnaround for the airline, which made £875 million in profits last year.

The collapse has been blamed on sustained high oil prices, which increased the airline's fuel bill by 49 per cent in the first quarter. BA now expects its fuel bill to be £3 billion this year, up from £2.1 billion.

Willie Walsh, BA's chief executive, said that the airline had increased fares partially to offset the cost of fuel and would reduce capacity in the quieter winter months.

It plans to cut capacity by 3.1 per cent, mostly by reducing the frequency of short-haul flights, although four routes in Europe will be cut entirely.

Mr Walsh called the present environment “the worst the industry has ever faced ... The combination of unprecedented oil prices, economic slowdown and weaker consumer confidence has led to substantially lower first-quarter profits.”

However, other airlines suggested that BA's chaotic move to its new home at Heathrow's Terminal 5 this year may also have been responsible for its drop in profits.

Paul Charles, a Virgin Atlantic spokesman, said: “While high oil prices are testing the strength of airline management across the industry, it is BA's waning popularity that is partly responsible for the actual sharp drop in profits.”

In the three months to June 30, BA's profits fell to £37 million from £298 million in the same period the year before. Its revenues increased by 2.8 per cent to £2.2 billion.

Andrew Fitchie, aviation analyst at Collins Stewart, said: “BA had a difficult start to the year, with the botched launch of Terminal 5. However, within the context of a very difficult operating environment, BA management is doing all the right things.”

Mr Walsh added that he would negotiate details of the Iberia merger with Fernando Conte, its chairman and chief executive, but insisted that he would stay with the enlarged group.

The proposed merger will create a new holding company with the two brands continuing to operate as separate entities. No decision has been made on who will run the company or where it will be based, but it will be listed in both London and Madrid.

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