The International Monetary Fund cut its global growth forecast and urged European policy makers to use “aggressive” monetary policy as a second year of contraction leaves the euro area’s recovery lagging behind the rest of the world.
The global economy will expand 3.3% this year, less than the 3.5% forecast in January, after 3.2% growth in 2012, the Washington-based fund said today, cutting its prediction for this year a fourth consecutive time. The Washington-based IMF sees the 17-country euro area shrinking 0.3%, compared with a 0.2% retreat in January, with France joining Spain and Italy in contracting.
“The main challenge is still very much in Europe,” IMF Chief Economist Olivier Blanchard said in a recorded statement released with the fund’s World Economic Outlook. “Europe should do everything it can to strengthen private demand. What this means is aggressive monetary policy and what this means is getting the financial system to be stronger -- it’s still not in great shape.”
As central banks in U.S. and Japan deploy unconventional policies such as asset purchases to rouse demand, pressure is mounting on the European Central Bank to do more. The IMF report describes a “three-speed” recovery led by emerging markets including China, with the U.S. forging ahead and Europe trailing after fighting a debt crisis that has forced bailouts of five countries in the region.
While a 50% chance of a recession in the euro region is the most immediate threat to global growth, failure to devise debt reduction plans in the U.S. and Japan over the medium term would also have consequences, according to the report.
Japan’s plans for fiscal stimulus and record monetary easing were reflected in the fund’s new forecasts for the world’s third-largest economy, which were raised to 1.6% this year from 1.2% and 1.4% in 2014 from 0.7%.
The U.S. growth projection was trimmed to 1.9%, from 2% in January to incorporate the expected impact of across-the-board spending cuts known as sequestration.
Still, a recovering housing market, improving confidence and the Federal Reserve’s accommodative monetary policy will help growth accelerate to 3% in 2014, the fund said.
The forecast for global growth next year is 4%, compared with 4.1% in the IMF’s January projections.
In the report, the fund said advanced economies had defused the two biggest threats to the global recovery -- a splintering of the euro region and the so-called U.S. fiscal cliff.
The Standard & Poor’s 500 Index jumped 10% from January through March, its biggest quarterly advance in a year, and closed at all-time highs twice last week. Japan’s Nikkei 225 surged 19.3%, its largest quarterly gain since mid-2009. The Euro Stoxx 50 Index, a measure of shares in nations using the common currency, dropped 0.5% in the three months through March.
“There appears to be a growing bifurcation between the United States on one hand and the euro area on the other,” Blanchard wrote in a foreword to the report. “Given the strong interconnections between countries, an uneven recovery is also a dangerous one.”
The euro region is still facing a contraction of credit as banks fail to translate low interest rates of the European Central Bank into affordable credit for companies and households.
“Because of insufficient financial repair, monetary policy is ‘spinning its wheels,’” IMF Managing Director Christine Lagarde said in a speech last week. “The priority must be to continue to clean up the banking system by recapitalizing, restructuring, or -- where necessary -- shutting down banks.”
The fund sees a contraction deepening in Italy to 1.5% from 1% in January and in Spain to 1.6% from 1.5%. France’s gross domestic product this year will shrink 0.1%, instead of growing 0.3% as predicted three months ago, the IMF report said.
The IMF said the ECB has room to cut interest rates further and suggested that the central bank’s bond-purchase program, which must be requested and has never been used, “be made available to countries with programs that are delivering on adjustment.”
With Germany’s economy forecast to grow 0.6%, less than the 0.9% expansion last year and unchanged from January, “this may call into question the ability of the core to help the periphery, if and when needed,” Blanchard wrote.
In contrast, challenges for many emerging and developing markets include avoiding over-stimulating their economies and managing capital flows, according to the report.
“Fundamentally attractive prospects in emerging market economies, together with low interest rates in advanced economies, are likely to lead to continuing net capital inflows and exchange-rate pressure in many emerging market economies,” Blanchard wrote. “This is a desirable process and part of the global rebalancing that must take place if the world economy is to get back to health.”
Developing economies are seen growing 5.3% this year, compared with 1.2% for their advanced counterparts, according to the report. While it’s less than the 5.5% forecast in January, it is still faster than expansion of 5.1% last year, according to the IMF.
China’s 2013 growth projection was cut to 8% from 8.2% and India’s to 5.7% from 5.9%, the report showed. While Brazil’s expansion was lowered to 3% from 3.5% in January, the forecast for next year was unchanged at 4%.
Still, inflation remains under control and commodity prices are set to decline 2% this year compared with 2012 as supplies increase for raw materials including crude oil and grain, the fund said.
In its report, the IMF said currencies generally “have responded appropriately to recent changes in macroeconomic policies and falling risk aversion.”
The yen has weakened about 12% against the U.S. dollar this year, British pound has dropped about 6% and the euro has slipped 0.5%, according to data compiled by Bloomberg.
“There are still many challenges and things can still go wrong,” Blanchard said in the recorded statement. “The recovery is just not assured.”