A Fragile Global Recovery?

Larry Elliott of the Guardian reports, Western economies too weak for spending cuts, IMF warns:

The International Monetary Fund today provided a boost for Labour's campaign strategy when it warned rich western countries that their economies were too weak for spending cuts, tax increases or higher interest rates.

In its influential World Economic Outlook, the IMF said the recovery in global growth over the past year had relied on "highly accommodative" policies and there was a risk of a relapse.

"In most advanced economies, fiscal and monetary policies should maintain a supportive thrust in 2010 to sustain growth and employment," the WEO said.

"Regarding the near term, given the fragile recovery, fiscal stimulus planned for 2010 should be fully implemented, except in countries that are suffering large increases in risk premiums," the IMF added.

The fund's comments are likely to be seized upon by Gordon Brown, who has been arguing the UK could suffer a double-dip recession if the Conservatives implemented plans for £6bn of spending cuts in an emergency post-election budget in June.

While raising concerns about the possibility of a sovereign debt crisis spreading from Greece, the Washington-based fund said action to tackle budget deficits should wait until 2011 for most countries, the point at which government plans for tax increases and spending restraint kick in: "If macroeconomic developments proceed as expected, most advanced economies should embark on significant fiscal consolidation in 2011. Countries urgently need to design and implement credible fiscal adjustment strategies, emphasising measures that support potential growth."

The fund added that central banks could keep interests low provided inflation remained low.

After experiencing the first contraction since 1945, global output is expected by the IMF to grow by 4.2% this year and by a further 4.3% in 2011. But it stressed that the multi-speed nature of the recovery would continue, with the advanced economies growing by 2.3% this year but China and India posting expansion of 10% and 8.8% respectively.

Europe will be the slowest-growing part of the global economy, with all five of the leading economies struggling to boost output by more than 1.5% this year. The fund has pencilled in growth of 1.3% for the UK this year, in line with Alistair Darling's budget forecast, and 2.5% in 2011, lower than the Treasury is expecting. The IMF's prediction for UK growth this year is unchanged on its last forecast in January, but it has shaved 0.2 points off its estimate for 2011.

"In the United Kingdom, the recovery is projected to continue at a moderate pace, with previous sterling depreciation bolstering net exports even as domestic demand likely remains subdued," the fund said.

It added that Spain should be braced for a second year of economic contraction in 2010, with Italy likely to grow by 0.8%, Germany by 1.2% and France by 1.5%. "Among the hardest hit during the global crisis, Europe is coming out of recession at a slower pace than other regions," the fund said.

It believes the pace of growth in the US will ease next year from 3.1% to 2.6% as the impact of big cuts in interest rates and an expansionary fiscal policy wear off.

"Extraordinary policy intervention since the crisis has all but eliminated the risk of a second Great Depression, laying the foundation for recovery," the fund said. "The interventions were essential to prevent a downward debt-deflation spiral, in which increasingly severe difficulties would have fed back and forth between the financial system and the rest of the economy."

Bank of Israel Governor Stanley Fischer, a former top official at the International Monetary Fund, also said advanced economies don’t face a deflationary threat and the U.S. economy is rebounding faster than anticipated:

Rising commodity costs and gains in global demand will prevent a downward spiral in consumer prices without sparking a surge in inflation, Fischer said in an interview in Washington yesterday. The U.S., U.K. and Canadian economies are growing quicker than was forecast when the global recession took hold, he said.

“I don’t think we’re going to see a serious deflationary threat in the countries that are recovering reasonably,” said Fischer, who was Federal Reserve Chairman Ben S. Bernanke’s thesis adviser. “I don’t want to say it’s an inflationary threat, inflation is going to be within comfortable ranges.”

Fischer said now isn’t the time for his central bank to stop buying foreign currency. He urged countries with mounting debt burdens to pare them and suggested the allegation of fraud at Goldman Sachs Group Inc. improves the chances of a regulatory overhaul of Wall Street.

While not enjoying a so-called v-shaped recovery, the U.S. is doing a “bit better than people expected,” he said. The IMF this week raised its forecast for the world’s largest economy to show growth of 3.1 percent this year, up from its January estimate of 2.7 percent and last year’s 2.4 percent contraction.

Ahead of Consensus

“If we think of all the scenarios we were listening to 1 1/2 years ago we’re well ahead of the consensus,” Fischer said.

Fischer, 66, last month accepted a second term as Israel’s central bank chief. From 2002 to 2005 he was a vice chairman at Citigroup Inc. having previously worked as the IMF’s first deputy managing director, where he helped resolve financial crises in Mexico, Russia and Southeast Asia.

With interest rates still near zero in the U.S. and other major economies and Israeli inflation above the government’s target of 1 percent to 3 percent, Fischer said his central bank is not ready to stop buying foreign currency. It began doing so in March 2008 and has more than doubled reserves since then in a bid to weaken the shekel to help exporters weather the global economic crisis.

“We’re not at that point yet,” Fischer said when asked if he can stop the two-year effort. “It’s a very uncomfortable situation and until we see interest rates around the world beginning to move in a direction which will return them to something more normal, markets are going to be very volatile.”

Surge in Yields

With a surge in Greece’s bond yields yesterday to the highest since 1998 putting pressure on its government to accept an international bailout, Fischer said aid would only work best if accompanied by efforts to cut the country’s budget deficit.

“The best sort of strategy is to undertake the measures that will solve the underlying problem,” Fischer said. “If you’re not going to adjust, but Greece is going to adjust, then you’re just making a bigger debt problem for the future.”

Asked whether Greece’s woes will prompt investors to start targeting other European economies with large budget gaps, Fischer said “it depends how well the other countries decide to deal with their problems.”

Fischer said last week’s announcement by the U.S. Securities and Exchange Commission that it is suing Goldman Sachs for alleged fraud linked to derivatives improves the “atmospherics” around a push to tighten regulation of the financial industry.

While the international campaign to regulate banks better is “being fragmented,” he said he would rather countries were advancing at their own speeds than not do anything.

“We’re seeing individual countries, individual groups of countries move,” he said. “It’s a good thing countries are moving ahead.”

On whether China should allow its yuan to appreciate, Fischer said doing so would help narrow international trade imbalances and temper the “threat of domestic overheating.”

Reading these articles, you sense experts are cautiously optimistic, but remember what was posted a few days ago, the second wave of the financial crisis will be brutal, especially if rates start spiraling out of control.