Diageo owns some of the best-known brands of drink

The firm, which makes Guinness beer and Smirnoff vodka, said sales in Europe are likely to have worsened during the second half of its financial year

Markets such as Nigeria and Korea are experiencing problems as well.

Diageo also said it expects to increase its compensation payments to the Thalidomide Trust to an annual �6.5m and hopes to agree the deal this year.

Future compensation

Thalidomide, a drug used to combat morning sickness in pregnant women but which caused birth defects, was originally distributed in the UK by a pharmaceutical subsidiary of the Distillers Company.

Distillers, the company which marketed the drug, was owned by Guinness, which after a merger became part of Diageo.

Diageo said it expects to finalise the agreement with the trust by the end of this year and will make the annual payments until 2037.

As a result the company is set to take an exceptional operating profit charge of about �150m in the year ended 30 June 2005 to cover the cost of the future compensation.

Diageo said that volume growth in the new financial year is likely to be little changed from the previous one.

It will focus on cost cutting, reorganisation and price increases in its strong US market to help drive operating profit growth.

The main area of concern is Europe, however, where the consumer environment has "worsened".

European "net sales, which were down 1% in the first half, are therefore likely to be down further in the second half," Diageo said.