IMF on WORLDS ECONOMY

IMF sees Japan GDP growth at 2.7 pct in 2006, domestic demand strong
Japan's economy is likely to grow 2.7 pct this year and by just over 2.0 pct in 2007 as the country's expansion continues, driven by solid domestic demand, the International Monetary Fund said.
In its latest World Economic Outlook, the IMF said private fixed investment in particular continues to be buoyant, underpinned by robust profits and a turnaround in bank credit.
Private consumption has increased at a slightly more moderate rate due to modest labor income gains, it said.
Signs are also emerging that Japan has escaped from seven years of entrenched deflation, with core inflation at about 0.25 pct in recent months.
Japan's key near-term macroeconomic policy challenge is now the normalization of monetary policy, the IMF said.
The Bank of Japan will have to eventually lift the nominal policy rate to more normal levels than the 25 basis points it was raised to in July after being pegged to zero since early 2001.
But the IMF noted that risks of a return to deflation in response to an adverse shock, such as a substantial slowdown in global growth, should not be ignored.
"The future path of the policy interest rate, therefore, needs to carefully balance the risks of a return to deflation against those of the possibility of accelerating inflation," it said, adding that Japan should clearly define its inflation goals.
In the medium-term, restoring fiscal stability is Japan's key macroeconomic challenge, the IMF said.
Structural fiscal reforms should be accompanied by broader reform efforts aimed at raising productivity growth, which would have a mutually reinforcing impact on fiscal sustainability, it added.
Priorities are the reforms of government financial institutions, strengthening of competition in the services sector, and enhanced labor market flexibility, the report said.
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IMF raises euro zone 2006 growth forecast to 2.4 pct, sees further rate hikes
The International Monetary Fund raised its forecasts for euro zone GDP growth to 2.4 pct from 2.0 pct this year and to 2.0 pct from 1.9 pct next year.
It said the euro zone recovery has gained traction, with growth reaching an annualised rate of 3.6 pct in the second quarter and set to remain strong over the remainder of the year.
"Recent indicators suggest that the pace of expansion in the euro area should be sustained during the second half," it said in its semiannual world economic outlook.
The IMF said the European Central Bank has been right to raise its key interest rate to 3.00 pct currently from 2.00 pct last December, but it should be cautious about the pace of further rate increases.
"Further interest rate increases will likely be needed to maintain price stability over the medium term if the expansion develops as expected," it said.
"But, with underlying inflationary pressures still well contained... policymakers can afford to be cautious in tightening the monetary policy stance, all the more so given the risk of euro appreciation and weaker growth in the US," it added.
The moderation in the pace of growth next year will partly be the result of the German VAT rate hike in January, the IMF said.
It said it expects German growth to accelerate to 2.0 pct this year but then to slow again to 1.3 pct next year, but said the VAT hike could lead to an even more marked slowdown.
It was previously forecasting German growth of 1.3 pct in 2006 and 1.0 pct in 2007.
Uncertainty over fiscal policy also affects Italy, where the new government is expected to take measures to bring the deficit under the EU stability pact limit of 3 pct of GDP next year.
The IMF raised its 2006 growth forecast for Italy to 1.5 pct from 1.2 pct, but lowered its 2007 forecast to 1.3 pct from 1.4 pct.
The fund lifted its projections for French GDP growth to 2.4 pct this year and 2.3 pct next year, from 2.0 and 2.1 pct respectively.
Spain is expected to grow 3.4 pct in 2006 and 3.0 pct in 2007.
The IMF said euro zone investment is expected to remain buoyant, but consumption will expand at a more moderate pace as a result of modest employment and wage growth.
It said the possibility of further euro appreciation represents a risk to the economic outlook.
"Against the background of large global imbalances, Europe remains exposed to the possibility of sharp currency appreciation that could undercut exports and investment in the in the traded goods sector and impose capital losses on holders of US dollar assets," it said.
Meanwhile, recent falls in equity markets could weigh on business and consumer confidence, while house prices in Spain and Ireland could come under pressure as interest rates rise, it added.
It said Europe needs to use the current expansion to boost productivity growth and make further progress on cutting fiscal deficits.
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IMF says US economy faces risk of 'abrupt slowdown' from slowing housing market
The US economy faces the risk of an "abrupt slowdown" if the housing market in the world's largest economy suffers a slump but at the same time further rate hikes may be needed to tackle inflation, the IMF said.
"The US housing market could cool more rapidly than expected, triggering a more abrupt slowdown of the US economy," the world body said in its economic outlook released today.
As things stand, the IMF expects a cooling US housing market to dampen US GDP growth in 2007 to 2.9 pct -- a downgrade from the 3.3 pct forecast made in April this year. It maintained the full year forecast for 2006 at 3.4 pct, however.
But while growth is seen coming off the boil, inflation is expected to stay at elevated levels, with CPI inflation rising to 3.6 pct in 2006 from 3.4 pct in 2005 before easing to 2.9 pct in 2007. This poses a problem for US rate setters.
"The US Federal Reserve faces a difficult situation of rising inflation in a slowing economy, but given the importance of keeping inflation expectations in check, some further policy tightening may still be needed," IMF said.
In August, the Fed ended its run of 17 straight rate hikes which took the benchmark rate from 1.00 pct to 5.25 pct. Markets are divided whether more increases are in the pipeline.
It also said that the US will have to do more to lower its current account gap. The US administration expects to halve its federal deficit by 2008, one year ahead of schedule but its plans may be a little premature, "given that a number of factors not fully reflected in the administration's forecast," the IMF said
Among others the IMF cited the cost of the military operations in Iraq and Afghanistan.
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