The New Nation - Internet Edition

Reuters, Frankfurt

The global economy faces its most difficult test in many years with economic growth slowing sharply even as high commodity prices put pressure on inflation, a senior International Monetary Fund official said on Tuesday.

IMF first deputy managing director John Lipsky said strains on financial markets remained significant more than a year after wider tensions from problems in US mortgage markets surfaced, constraining growth and banks' balance sheets.

Commodity prices remained high and volatile, bringing risks of knock-on inflation effects, but recent sharp falls in oil prices should ease short-term inflation pressures in advanced economies.

Central banks in advanced economies could afford to keep rates on hold and, in regions with high real rates, look out for easing price pressures which would allow them to loosen policy down the track, he said.

'Against the backdrop of protracted financial strains and dramatic surges in commodity prices, the global economy is confronted with its most difficult set of circumstances in many years,' Lipsky said in remarks prepared for delivery to a conference organised by Germany's Die Zeit newspaper.

'Advanced economies, in general, face a spell of growth well below potential, as they grapple with ongoing strains from the financial crisis that began a year ago, as well as high oil prices and weaker external demand.'

Inflation was at its highest since the late 1990s, and recent falls in commodity prices would offer only limited respite as past increases were still in the pipeline.

Lipsky said the IMF saw global growth slowing from 5 per cent in 2007 to about 3 per cent late in 2008, reaccelerating toward 4 per cent in the course of 2009, although he said the specific figures were still under review and would be released in the World Economic Outlook next month.

The IMF's last forecasts, from mid-July, were for global growth of 4.1 per cent in 2008 and 3.9 per cent in 2009.

For the United States, where housing markets continued to weigh on consumption, growth would slow to about 1 per cent in 2008 on a fourth-quarter-on-fourth-quarter basis and recover gradually to about 1.5 per cent in 2009. In mid-July, the IMF forecast growth of 0.3 per cent in 2008 and 1.9 per cent in 2009.

In the euro area, the IMF projected growth on the same basis at about 0.75 per cent in 2008 and about 1.5 per cent in 2009, from 1.3 per cent and 1.7 per cent respectively in mid-July.

Emerging growth in emerging and developing economies was projected at just over 6 per cent in 2008 before reaccelerating to more than 7 per cent in 2009. In July, the IMF saw emerging economies growing at 6.3 per cent this year and 7.5 per cent next year.

Lipsky said although the IMF expected commodity prices to remain high in real terms, slower growth and recent falls in oil prices should help contain inflation pressure in advanced economies.

'Thus, policymakers can afford to keep rates on hold in the face of elevated headline inflation, while watching closely for signs of easing price pressure that would permit a more accommodative stance in economies with relatively high real interest rates,' he said.

But in emerging markets, inflation pressures were building while real interest rates remained low and some central banks may be 'behind the curve' with their monetary policy.

'Policies in these instances need to be tightened, lest central banks run the risk that hard-won policy credibility could be eroded.