Rich nations have taken the first step toward winding down measures designed to rescue their economies amid tentative signs of recovery, reassuring investors who had begun to fret about inflation, but will not move to withdraw stimulus plans yet.
Group of Eight finance ministers meeting in Lecce, southern Italy, at the weekend described their economies in the most positive terms since the collapse of Lehman Brothers nine months ago ushered in the world's worst financial crisis since the Great Depression of the 1930s.
“There are signs of stabilization in our economies, including a recovery of stock markets, a decline in interest rate spreads, improved business and consumer confidence,” the finance ministers said in their end-of-meeting communiqué.
“But the situation remains uncertain and significant risks remain to economic and financial stability.” Underlining the fragile state of the nascent recovery, an influential Chinese economist said that China would not see a rapid rebound and South Korea's finance minister said its economy was still sliding, although the pace had slowed.
In Britain, a leading business group said the country would pull out of recession earlier than previously forecast, but that a sustained recovery was not assured.
A surge in long-term government bond yields in recent weeks showed financial markets fear huge sums of money poured into economies through drastic stimulus packages will ultimately fuel inflation. A sharp run-up in prices could force central banks to hike interest rates sooner than expected, potentially choking off a recovery.
Pressure has been building in the G8, particularly from fiscally conservative nations such as Germany and Canada, for plans to wind down stimulus as soon as it is no longer needed. Such “exit strategies” may prevent market interest rates from climbing high enough to threaten economic recovery.
But ministers in Lecce clearly differed over how quickly the world should start rolling back huge state spending plans and hiking interest rates.
The meeting's final joint statement said they had asked the International Monetary Fund to help them analyze possible ways of ending economic stimulus policies. Most private sector economists do not expect any major tightening of fiscal and monetary policies in the developed world before next year.
The communiqué stressed there would be no immediate end to stimulus, noting unemployment might continue rising even if production began picking up. “While the economic outlook is improving, the situation remains uncertain,” it said.
US Treasury Secretary Timothy Geithner indicated the United States was unlikely to tighten policy any time soon: “It is too early to shift toward policy restraint.”
Asian shares fell on Monday and the dollar rose broadly, with some market players saying the cautious tone from the G8 gathering had prompted investors to cut back their bets on riskier assets.
The dollar was also supported by remarks from a top Kremlin aide, who said the leaders of Russia, China, India and Brazil did not intend to discuss new global reserve currencies at the first summit of the so-called BRIC group on Tuesday.
Russia, holder of the world's third largest foreign exchange reserves, has called for the world to become less dependent on the dollar and suggested that the yuan and the ruble could become reserve currencies in the future.
“We've verified that markets have bottomed out but we have yet to see what sort of form the recovery will take and we need clear proof that it will continue,” said Masayoshi Okamoto, head of trading at Jujiya Securities.
Hopes of a global economic revival were boosted last week by a jump in Chinese factory output data for May, suggesting massive state stimulus spending was compensating for a drop of in demand for the exports that fueled China's growth in recent years.
But Li Yang, a former adviser to the People's Bank of China, the central bank, said he expected China's recovery to be “W-shaped” - meaning that growth would falter once current fiscal and monetary stimulus wears off before regaining momentum.
“China should not count on a turnaround of external demand to bring about its recovery,” Li, director of the finance institute at the Chinese Academy of Social Sciences, was quoted by the Shanghai Securities News on Monday as saying.
South Korean Finance Minister Yoon Jeung-hyun said its government would be able to say if Asia's fourth-largest economy has bottomed out after gross domestic product data for the current quarter is released late next month.
“The economy is certainly still sliding, although the pace of decline is slowing,” he said. “Let me make it clear that we are not at the stage for a change in the aggressive fiscal stimulus and financial easing policy stance.”
A report from the Confederation of British Industry on Monday forecast its economy would stabilize late this year, but said it would take until the beginning of 2010 to return to growth. (Reuters)