Posts here late last year suggested the consensus was too fixated on US recession risk and was neglecting a possible sharp slowdown in Europe. This was based partly on my monetary leading indicators, which were signalling more expansionary conditions in the US.

The US economy has shown greater resilience than most economists expected but the forecast seemed to be going awry in early 2008, with Eurozone GDP climbing at a 3.2% annualised rate in the first quarter versus 1.0% in the US. However, the Eurozone figures were distorted by several factors and little if any increase is expected in the second quarter. Meanwhile, available US evidence suggests GDP grew by about 2% annualised last quarter.

This week’s purchasing managers’ surveys offer further support for the notion that the US now has greater momentum. The first chart shows a weighted average of new business indices from the manufacturing and services surveys – this indicator is usually a good coincident indicator of quarterly GDP growth, with readings below 46 suggesting economic contraction. Soaring energy costs contributed to a general softening of confidence last month but the Eurozone indicator has now crossed beneath its US counterpart. Within Euroland, the Spanish (and Irish) indicators are now deep in recession territory. The UK is also flirting with contraction.

Since late last year my favoured scenario has involved a fall in annual G7 industrial output growth to 0-1% by mid 2008 followed by a US-led recovery during the second half. However, mounting weakness in Europe was identified as a key risk to the forecast.

As the second chart shows, the scenario has played out well during the first half but the expected second-half recovery could be aborted by the recent further surge in commodity prices – this risk was also discussed in previous posts criticising the Fed’s excessive policy easing. This is not yet my forecast but higher input costs will restrain any reacceleration in the US economy while exacerbating weakness in Europe.

Economists who argued late last year that the credit crisis would lead to a hard landing and deflation in 2008 have been very wrong. The global economy has been much more resilient than they expected and the risks stem not from deflation but the inflation caused by the Fed’s excessive rate cuts, which those same economists cheered on.