The International Monetary Fund on Tuesday shaved projections for global economic growth for this year and next to take into account sharp government spending cuts in the United States and the latest struggles of recession-stricken Europe.
While it said economic prospects had improved in recent months with a fading of financial risks, it warned Europe against relaxing efforts to combat its debt crisis given the messy bailout in Cyprus and political stalemate in Italy.
The IMF also upwardly revised its forecast for Japan, welcoming the Bank of Japan's aggressive new monetary stimulus, which it said would boost growth and help vanquish deflation.
"Global economic prospects have improved again but the road to recovery in the advanced economies will remain bumpy," the IMF said in its periodic World Economic Outlook released ahead of meetings later this week of global finance leaders.
"While tail risks to the global outlook have diminished and upside risks now exist, downside risks still predominate and could have important spillovers across regions," it added.
The IMF cut its 2013 forecast for global growth to 3.3 percent, down from its January projection of 3.5 percent. It also trimmed its 2014 forecast to 4.0 percent from 4.1 percent.
A more subdued outlook for the United States and for the eurozone led it to lower its forecast for advanced economies to 1.2 percent for 2013 while it kept its 2014 forecast at 2.2 percent.
While it lowered its projections for growth in emerging economies to 5.3 percent for this year, it also said growth was already accelerating and would hit 5.7 percent in 2014. Growth has returned to a healthy pace in China and activity is expected to recover in Brazil next year, the IMF said.
Strong domestic demand in sub-Saharan Africa should help boost growth in both resource-rich and poorer economies in that region, the Fund added. Meanwhile, growth in the Middle East and North Africa is likely to dip this year as oil production slows in some oil-exporting nations and "Arab Spring" countries struggle with political transitions.
"Notwithstanding old dangers and new turbulence, the near-term risk picture has improved as recent policy actions in Europe and the United States have addressed some of the gravest short-term risks," the Fund said.
BOJ ON TRACK BUT NEEDS HELP
The IMF welcomed the radical overhaul of monetary policy the Bank of Japan announced this month to end two decades of deflation.
The Fund also said inflation in Japan would likely rise above zero in 2013 and temporarily jump in 2014 and 2015 in response to an increase in consumption tax.
The Bank of Japan unleashed an intense burst of monetary stimulus earlier this month, pledging to inject about $1.4 trillion into the economy in less than two years, a major shift from its previous incremental steps.
"For it to be a successful and achieve 2 percent inflation within two years, easing must be accompanied by ambitious growth and fiscal reforms to ensure a sustained recovery and reduce fiscal risks," the IMF said, also warning Japan that its public debt burden was unsustainable.
Tokyo came under fire before a meeting of officials from the Group of 20 leading economies in February for comments that suggested it was targeting specific levels for the yen with its easing of monetary and fiscal policy. The yen last week hit a four-year low against the dollar.
But the IMF said it found "no large deviations of the major currencies from medium-term fundamentals" and dismissed talk of a "currency war" as overblown. It said the U.S. dollar and euro "appear moderately over-valued" and the Chinese renminbi "moderately undervalued." Evidence on the value of the yen "is mixed," it added.
FIRST FED RATE INCREASE IN 2016
The IMF said Europe and the United States had dodged bullets by enacting policies that laid to rest the notion of a euro zone breakup and the possibility the world's richest economy would fall off a "fiscal cliff" of tax increases and budget cuts.
However, it suggested an easier monetary policy might be warranted in the euro zone.
"Given moderating inflation pressure, monetary policy should remain very accommodative. Room is still available for further conventional easing, as inflation is projected to fall below the European Central Bank's target in the medium term," it said.
The Fund also made clear that, while a worst-case outcome had been avoided, fiscal policy in Washington had tightened more than it had expected - a key reason for its forecast downgrade.
It said across-the-board spending cuts known as the "sequester" would shave about 0.3 percentage points from gross domestic product this year, the IMF said. If the sequester continued into the next fiscal year, it could trim another 0.2 percentage points from GDP growth, the IMF added.
As for U.S. monetary policy, it said it expected the Federal Reserve to hold interest rates near zero into early 2016, although it cautioned that the Fed may need to tighten policy earlier "should upside risks to growth materialize."
The Fed last month maintained a controversial program of buying $85 billion of bonds a month, while pledging to keep interest rates near zero until unemployment hits at least 6.5 percent, so long as inflation stays under 2.5 percent.
The Fund said developing a comprehensive medium-term deficit reduction framework that reformed so-called entitlement programs and raised additional revenues should be the top priority for the United States.
"Such a comprehensive plan should place fiscal consolidation on a gradual path in the short term, in light of the fragile recovery and limited room for monetary policy," the IMF added.
(Reporting by Lesley Wroughton; Editing by Tim Ahmann and Theodore d'Afflisio)