The first chart below shows updated versions of my soft and hard landing scenarios for G7 industrial output growth. As explained here, the scenarios are based on average performance in prior soft and hard economic downswings over the last 40 years. The new versions have been adjusted to take account of the recent path of output growth.

Economic news will be weak in early 2008 but I think the odds still favour an outcome closer to the soft than hard landing scenario, for three main reasons. First, G7 monetary conditions are loosening, which should provide increasing support for economic activity as the year progresses – see second chart. Secondly, corporate profitability is high by historical standards, which should limit weakness in investment and labour demand. Thirdly, emerging economies should remain strong, reflecting their own loose monetary conditions.

The version of my US recession probability indicator incorporating credit spreads stood at 42% in December – dangerously close to the 50% “trigger” level. However, projecting the indicator forward based on current values of the inputs suggests a decline in recession risk by the summer. The extent of US economic weakness in early 2008 is unclear but prospects of a recovery later in the year are improving.

The key negative factors for the outlook are the “credit crunch” and soaring energy costs. Fed and ECB surveys to be released over the next few weeks will provide important new information on credit conditions. A meaningful fall in the oil price would be a big boost to the soft landing case.