For the last couple of months my ECB-ometer model has suggested a neutral policy stance was warranted by economic data and financial market developments (see here). The statement issued after last week’s ECB meeting retained a hawkish slant but, as the FT has reported, comments from officials this week have been more ambiguous and may indicate the balance of opinion on the Governing Council is shifting.

The ECB-ometer attempts to estimate the average interest rate recommendation of Governing Council members each month. A reading of above 12.5 basis points generates a forecast of a 25 bp rise in the ECB’s repo rate; below -12.5 bp predicts a quarter-point cut. The chart below shows the history of official interest rate changes and the model’s forecasts since the ECB’s inception .

Based on the latest information, the ECB-ometer’s forecast for the February ECB meeting is 0 bp, implying an exactly neutral policy stance. The ECB may be toning down its hawkishness but the model suggests economic news needs to change significantly to warrant hopes of a rate cut. As well as more evidence of a serious slowdown, Governing Council members are likely to require falls in money supply expansion and household inflation expectations before contemplating a dovish shift.

The recent small decline in the euro may indicate the market is sensing a turn in the Eurozone interest rate cycle but a sustained reversal against the dollar probably also requires investors to believe that the next cut in US official rates will be the last for some time.

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.