Fiscal austerity in Europe demanded by markets and exacted by Germany as the price for saving the euro currency is taking its toll on the world economy. A global slowdown is spreading.

Its severity rests largely upon whether financial markets remain confident that European Union leaders have delivered a euro-zone rescue plan with strong enough protections to support their bond markets and halt the spread of the sovereign debt crisis.

If markets lose confidence, financial contagion will spread and further damage a vulnerable global economy.

EU leaders agreed last week on deeper economic and fiscal union for euro zone members, but uncertainty is rampant over whether Europe has constructed firewalls strong enough to prevent further bond market sell-offs. Neither the European Central Bank, the European bailout fund nor the International Monetary Fund have sufficient resources to backstop the euro zone.

Analysts warn this leaves the global economy exposed to further financial turmoil in the weeks and months ahead. Already, emerging markets are facing a credit squeeze as Europe's banks sell assets and bring money back home to strengthen their balance sheets. This looks set to worsen after the European Banking Authority last week said the region's banks must raise 115 billion euros in extra capital.

An Institute of International Finance bank lending survey found that domestic funding conditions for emerging markets tightened sharply from June to September. Since then credit tightness has persisted and deepened, said IIF Deputy Managing Director Hung Tran.

Trade finance also is tightening as European sovereign credits are downgraded, pushing the cost of government-backed trade insurance above those for emerging countries, he said.

If this dries up, the wheels of global commerce can decline very quickly, Tran said.

Shipping brokers in the Pacific report a decline in business activity, an early sign that world trade is declining, although the Baltic Dry Goods Index, a global measure, has stabilised. In the euro zone, money supply began contracting in October, with the sharpest reductions from the five troubled periphery countries.

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For IFR's forecasts for the week ahead in U.S. economic data, please click on: http://graphics.thomsonreuters.com/11/12/IFRPV121211.pdf

NO ISLANDS

The United States stands alone among major developed economies in reporting its economy is gradually improving. Consumer sentiment brightened in early December, auto sales are climbing, order books are filling up and unemployment retreating. This will strengthen its resilience against the global slowdown and Europe's woes.

If the European crisis is contained, analysts say it will shave only a few tenths of a percentage point off U.S. GDP growth, currently seen around a 2.5 to 3 percent rate. But the financial contagion could worsen and pull down growth.

No country is a financial island. We would feel the effects of the slowdown spreading in the first quarter of next year, said Kathy Jones, bond strategist for Charles Schwab.

The Federal Reserve at its Tuesday meeting is expected to take no fresh action to support growth, although it may discuss ways to communicate the future path of its monetary policy in preparation for any additional easing measures next year.

Much of Europe is widely seen as already in recession. Even in Germany, the euro zone's powerhouse, the central bank slashed its 2012 growth forecast last week to 0.6 percent from 1.8 percent. An early read of the PMI manufacturing survey due on Thursday will measure the speed of the downturn.

In China, the manufacturing sector also is contracting as Europe, its largest trading partner, stumbles. Industrial output dropped in November to its lowest level in two years and producer prices slowed sharply. The government sets its economic policy goals in a three-day meeting this week where flexibility for pro-growth policies such as higher lending targets and monetary easing is expected.

Japan's capital spending contracted unexpectedly in the third quarter, a bad omen for future growth. A negative reading is expected when it releases its quarterly Tankan report on Thursday.

Several U.S. chipmakers, Texas Instruments and Altera , have cut their revenue outlooks, citing weakening demand for personal computers, a harbinger of a downturn strongly linked to Asia.

A major surprise last week was Brazil. Its go-go economy stalled in the third quarter despite aggressive monetary easing over the past three months. Cheap imports thanks to its soaring currency -- a byproduct of investors fleeing crisis-wracked developed markets, particularly in Europe -- have overwhelmed Brazilian producers, who have lost competitiveness in an integrated global economy. (Editing by Dan Grebler)