In forecast presentations late last year I suggested G7 industrial activity was entering a downswing phase. To get an idea of how the slowdown might play out, I examined 10 G7 downswings over the last 40 years, separating them into five “soft” and five “hard” landings – the latter associated with US recessions. I then averaged performance across these two groups to construct “soft” and “hard” landing scenarios for annual G7 industrial output growth in the current cycle.

A key conclusion of the analysis was that “soft” and “hard” landings look similar for the first 12-15 months after a cyclical peak. The averages showed annual output growth slowing steadily to about zero in both cases. It is only after 15-18 months that the two diverge significantly: activity starts to regain momentum in “soft” landings but shifts from stagnation to contraction in “hard” landings / US recessions.

The chart below is an update of one used last year, superimposing the “soft” and “hard” landing scenarios on the current cycle. Annual industrial output growth peaked at 4.5% in September 2006 and fell to 1.7% by June 2007 before recovering to 2.3% in September, the latest reading. The recent minor improvement will be cut short by the “credit crunch” and a renewed decline to 1% or below is likely by early 2008.

As the chart shows, the current downswing is about to reach the critical stage dividing historical “soft” and “hard” landings. Soaring energy costs and escalating credit market losses are clearly unhelpful but I still think the odds favour a "soft" landing like 1995 or 1998 rather than a 2001-style recession.