Weathering the eurostorm in 2011

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We've blogged in the last couple of days about access to finance and commodity prices. The third of our four forces to watch in 2011 is the eurozone crisis. Will it get worse, will it pass over, or will it be much like 2010, muddling through with a bailout or two for weak peripheral countries but no major collapse? And what will be the consequences for the UK?

2011 has kicked off in a very similar fashion to 2010 with the Guardian reporting heightened nerves regarding Portugal's growth prospects - a familiar sound to what preceded the Irish bailout late last year. How will this impact on exports to the eurozone?

Our Economic Prospects report out yesterday shows that a testing 2010 did see exports to struggling eurozone economies go backwards. In fact, exports to many other eurozone countries went backwards too, including France and the Netherlands - not usually listed with the sovereign debt basket cases. The one notable exception was Germany where the share of UK export growth was similar to Germany's share of UK total exports.

One of the PM's favourite rallying calls to action is that we export more to Ireland than all the BRICs combined. True maybe but on the other hand exporters are fast remedying that through strong growth to these key markets. So despite lacklustre demand from Europe, UK exports grew strongly overall with demand from key emerging markets more than compensating. With growth prospects for Europe and emerging markets continuing to show a divergent story in 2011, much the same pattern could repeat itself.

That's not to say that Europe's prospects aren't still very important for the UK economy. In its December meeting minutes the MPC talks about three generalised impacts from the sovereign crisis in order of impact: a reduction in exports to stricken markets, a generalised loss of confidence, and a systemic failure transmitted through the financial system. So far we've only really seen the first impact - and this has been offset to a degree by a strong Germany.

If on the other hand confidence were to start to fall and the eurozone's prospects for holding the euro together were to weaken considerably there is a possibility the pound could start appreciating considerably. Because such a large stock of UK trade still goes to and comes from Europe this is likely to reduce exports to and increase imports from Europe. The contribution from net trade to growth would be considerably reduced. We model one such scenario in Economic Prospects with a 10% appreciation against our central forecast, which in the short run drastically reduces the much sought after boost to growth from net trade.

So even the eurozone storm has so far failed to seriously impact on the UK, it is a key one to keep watching in 2011.

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