The volcanic ash cloud that has disrupted European air travel for several days should have a modest economic impact in the short term, but if it persists it could come to represent a drag on growth, says TD Economics.

In a research note issued Tuesday, TD suggests that in the short term, the most immediate economic impact from the eruption of the Icelandic volcano, Eyjafjallajökull, will be in the form of higher prices in markets which have seen supply disruptions. “However, this will only translate into small increases in overall headline inflation,” it finds.

The firm also says that the economic cost in terms of trade has so far been very limited, “as the bulk of merchandise trade across Europe takes place through sea and land.”

Certainly airlines have been disrupted by the event. Scotia Economics says that the eruption is adding at least US$250 million in losses for each day that flights to and from Europe are cancelled.

Although as TD notes, what has been a negative for airlines has boosted revenues for hotels handling stranded passengers and alternative forms of transportation, such as rail lines, car rental agencies and ferry services. “Thus, what has been detrimental for airlines, in contrast, has had positive or no impact in other tourism areas.”

“Beyond the costs and lost revenues incurred thus far by airlines and some perishables’ producers, if the impact of the eruption continues to abate in the next few days, its economic impact would be limited to some spikes in a small set of prices,” TD concludes. “However, the longer this phenomenon persists, the higher its economic impact on lost output.”

TD says that the fact that some airports in Europe have been reopened, and flight bans are being lifted, “is a positive sign, but it does not mean volcanic activity has stopped.”

“Before the eruption we were looking for a sluggish recovery in the European Union, with a growth forecast of 1.7% in 2010. Assuming that the disruptions from volcanic ash diminish in the near term, the impact of this event would not warrant a material change in our forecast. However, the downside risk would be a lower profile of growth in the range of 0.7% to 1.2% if the disruption continued over several months,” it concludes.

IE