Retail profitability may “surprise on the upside” next year but 2011 will be a “crunch year”, according to sector-wide analysis by brokers.

Shore analyst Kate Calvert said conditions in 2010 would remain “distinctly unhelpful” for stores as rising unemployment and higher taxation hit consumer demand.

But she said retailers’ self-help initiatives, such as strong control of inventory and costs, combined with pan-industry benefits such as the possibility of currency pressures abating gave grounds for optimism.

As a general election looms, she said: “The first priority for the new government will be addressing debt levels by increasing taxation and cutting public spending. Both are potentially negative for consumer sentiment and spending.”

She added: “We view calendar 2011 as a crunch year economically, depending on future government fiscal and budgetary policy. Consequently, short-term sector performance will remain a trade-off between earnings upgrades and longer-term economic concerns.”

Altium Securities analyst Dave Stoddart also issued a note arguing that “many of the fears for 2010 concern factors that we suspect will not impact until 2011”.

The cash generation and multichannel strengths of Argos-owner Home Retail Group and fashion giant Next made them Shore’s top sector picks, along with department store group Debenhams for its “structurally improving gross margin story”. WHSmith and Halfords both display “defensive and self-help merits” said Calvert, while Burberry “is best placed to play a global economic recovery”.

Stoddart also included WHSmith as a buy, alongside Game and HMV. He said: “Our caution on the economy leaves us suspicious of a housing market recovery, on the basis of which we remain sellers of Carpetright and Topps Tiles.”

Calvert said that retailers generally had done better than expected in offsetting currency pressures as a result of cost inflation because of the strength of the dollar.

She said: “Since March, sterling has strengthened and while it was too late for many retailers for this autumn/winter’s ranges, the recent strengthening in sterling versus the dollar does mean currency may now be a one-year issue rather than two.”

But Stoddart maintained that UK interest rates may stay lower for longer than elsewhere, raising the possibility of sterling “becoming the currency of choice for the international carry trade”. That, he said, would increase the sterling cost of imported goods and threaten retailers’ gross margin.