Europe and the United States could slip back into recession next year unless they quickly tackle economic problems that could infect the rest of the world, the International Monetary Fund said on Tuesday.
The IMF said financial volatility had increased dramatically as investors worried about an escalating debt crisis in the euro zone and a weakening U.S. recovery.
Those two regions present the biggest risks to the global economic outlook, it said, warning that political gridlock could block remedial action. The fund also called for a more ambitious plan to lower Japan's public debt.
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"Policy indecision has exacerbated uncertainty and added to financial strains, feeding back into the real economy," the IMF said in its latest World Economic Outlook report.
The IMF cut its forecast for global growth to 4.0 percent for this year and next, shaving projections for almost every region of the world and saying risks remained tilted to the downside. Just three months ago it had projected an expansion of 4.3 percent for 2011 and 4.5 percent for 2012.
The IMF's message to European leaders was they should do whatever it takes to preserve confidence in national policies and the euro, and it urged the European Central Bank to lower interest rates if risks to growth persisted.
Investors have questioned Europe's ability to come up with a convincing solution to its festering sovereign debt crisis, which has rattled confidence and roiled financial markets.
On Monday, international lenders told Greece to shrink its public sector and improve tax collection to avoid running out of money within weeks, and Standard & Poor's downgraded its unsolicited ratings on Italy by one notch and kept its outlook on negative — a move that surprised markets.
The fund cut its growth forecast for the 17-nation euro zone by nearly half a percentage point to 1.6 percent in 2011 and even weaker conditions are seen for next year with growth of just 1.1 percent. Currently the single currency region is scarcely growing at a 0.25 percent annual rate.
The IMF cautioned that hasty budget cuts in the United States could further weaken growth, and it said the U.S. Federal Reserve should stand ready to ease monetary policy further. The Fed meets on Tuesday and Wednesday.
The IMF shaved its forecasts for U.S. growth to 1.5 percent for 2011 and 1.8 percent for 2012, down from June projection of 2.5 percent and 2.7 percent, respectively.
WEAK AND BUMPY RECOVERY
Japan's economy was forecast to shrink 0.5 percent this year, not quite as severely as previously thought, but to grow just 2.3 percent in 2012. In June, the IMF said Japan would likely grow 2.9 percent next year.
Taken together, advanced economies, including the United States, euro zone and Japan, were forecast to expand 1.6 percent this year and 1.9 percent next year. That marks sharp downward revisions from June's 2.2 percent and 2.6 percent projections.
The outlook, it said, was for a "weak and bumpy expansion."
The IMF also said prospects for emerging market economies were growing more uncertain, although growth would likely remain fairly strong at about 6.4 percent this year, slowing to 6.1 percent in 2012.
Signs of overheating still warranted close attention in emerging market economies, it cautioned. In some countries, higher commodity prices and social and political unrest loomed large, it added.
The fund trimmed its forecasts for China and other emerging Asian economies, in part due to slowing global growth.
Asian "growth remains strong, although it is moderating with emerging capacity constraints and weaker external demand," the IMF said.
It said it expects China's economy to grow 9.5 percent in 2011 and 9.0 percent in 2012. That's down from its June forecasts of 9.6 percent this year and 9.5 percent in 2012.
The IMF said headline and core inflation had been on the rise in many parts of the world until recently. An IMF inflation tracker showed inflation pressures were still relatively elevated in emerging and developing economies. But in major advanced economies, inflation had been losing momentum.
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