The economic scenario viewed here as most likely involves the current "soft patch" in global industrial activity continuing into the autumn but falling short of a "double dip", with a revival of momentum following in early 2011. Recent news seems consistent with this script.

The first chart below shows six-month growth rates of G7 plus emerging E7 industrial output and a composite leading index derived mainly from OECD country indices. A "leading indicator of the leading index" is also plotted, based on its shorter-term momentum.

The leading index itself continued to slow sharply in August and its recent weakness is now being reflected in industrial output. The double-leading indicator, however, moved up from zero, suggesting that six-month growth in the index will bottom at this level within the next couple of months, with output itself following around end-2010. The rise was marginal but the indicator is a smooth series and usually gives reliable signals of turning points.

An upturn from late 2010 would be consistent with recent better G7 monetary trends: six-month growth in real M1 troughed in January 2010 and led the leading index and industrial output by 8-9 months and 11 months respectively at the last two turning points – see previous post. Available September figures suggest that the real M1 pick-up has been sustained, although the rate of expansion is much lower than in late 2008 and early 2009 – second chart.

What could go wrong? QE2, arguably, poses the greatest risk – any direct economic boost from a further monetary injection is likely to be outweighed by associated strength in commodity prices, which will cut real incomes and increase pressure for E7 policy tightening. Optimists should hope that the Fed reins back on its plans – markets would suffer a short-term setback but the price would be worth paying for a more stable economic outlook.