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IMF Cuts Global Outlook as Risk of ‘Frothy’ Stocks Raised

The International Monetary Fund cut its outlook for global growth in 2015 and warned about the risks of rising geopolitical tensions and a financial-market correction as stocks reach “frothy” levels.

The world economy will grow 3.8 percent next year, compared with a July forecast for 4 percent, after a 3.3 percent expansion this year, the Washington-based IMF said. U.S. growth is helping lead a worldwide acceleration that’s weaker than the fund predicted 2 1/2 months ago as the outlooks for the euro area, Brazil, Russia and Japan deteriorate.

“In advanced economies, the legacies of the precrisis boom and the subsequent crisis, including high private and public debt, still cast a shadow on the recovery,” the IMF said in its latest World Economic Outlook. “Emerging markets are adjusting to rates of economic growth lower than those reached in the precrisis boom and the postcrisis recovery.”

The outlook buttressed the case made by IMF Managing Director Christine Lagarde, who warned last week that officials need to act to prevent a prolonged period of sluggish growth, a trend she called the “New Mediocre.” Raising growth in emerging and advanced economies “must remain a priority,” the IMF report stated.

“We see the major risk in the stalling of the euro zone,” IMF Economic Counselor Olivier Blanchard said in an interview on Bloomberg Television. “The risk of recession is there,” he said, adding that European authorities should increase infrastructure spending to boost growth. Close

“We see the major risk in the stalling of the euro zone,” IMF Economic Counselor Olivier Blanchard said in an interview on Bloomberg Television. “The risk of recession is there,” he said, adding that European authorities should increase infrastructure spending to boost growth.

Stocks Retreat

The Standard & Poor’s 500 Index declined for a second day, falling 0.7 percent to 1,950.79 at 1:07 p.m. in New York. The equity benchmark is about 3 percent lower than a record reached on Sept. 18. The MSCI World Index dropped 0.6 percent to 1,670.23.

According to the report, a sustained period of policy interest rates near zero in advanced economies has raised the risk that some financial markets may be overheating.

“Downside risks related to an equity price correction in 2014 have also risen, consistent with the notion that some valuations could be frothy,” the lender said without naming specific markets.

The U.S. is a bright spot, according to the IMF. The world’s largest economy is predicted to grow 2.2 percent this year, compared with a 1.7 percent projection in July. Next year, the the U.S. is seen expanding 3.1 percent, compared with a 3 percent pace forecast in July.

Fed Tightening

The IMF said it expects the Federal Reserve to start raising interest rates in the middle of next year, a projection that’s in line with the median estimate of economists surveyed by Bloomberg. The U.S. central bank has held the federal funds target rate near zero since December 2008.

“The slack in the economy, well-anchored inflation expectations, and downside risks to the outlook imply that the current accommodative monetary policy remains appropriate,” according to the fund.

The euro area will grow 1.3 percent next year, slower than the 1.5 percent pace predicted in July, after a 0.8 percent gain this year, according to the IMF.

“We see the major risk in the stalling of the euro zone,” IMF Economic Counselor Olivier Blanchard said in an interview on Bloomberg Television. “The risk of recession is there,” he said, adding that European authorities should increase infrastructure spending to boost growth.

If inflation doesn’t improve in the currency bloc, the European Central Bank may need to do more to stave off deflation, including the purchase of sovereign bonds, according to the fund.

Japan’s Expansion

Japan, where consumer spending has been curbed by a sales-tax increase, also had its outlook cut. The IMF said Japan’s economy will expand 0.8 percent next year, compared with a 1.1 percent advance predicted in July.

Among emerging markets, Brazil suffered the biggest cut to its growth outlook. The country’s economy is expected to grow 0.3 percent in 2014, down from the IMF forecast of 1.3 percent in July. The IMF now sees Brazil growing 1.4 percent next year, compared with 2 percent in July.

China is forecast to expand 7.4 percent this year and 7.1 percent next year, little changed from the fund’s forecasts in July.

The fund said it is concerned some investors may be “underpricing risk” and “not fully internalizing the uncertainties surrounding the macroeconomic outlook and their implications for the pace of withdrawal of monetary stimulus in some major advanced economies.”

Crisis Watch

The IMF’s ability to spot coming crises such as potential asset bubbles is the subject of debate among academics, former officials and its own staff.

An advisory panel that included former Russian Finance Minister Alexei Kudrin and former Mexican central bank governor Guillermo Ortiz reported last week that the fund is in danger of missing “the big risks” because it tries to spot “every risk ‘under the sun.’”

A staff assessment, released alongside the advisory report, said the IMF needs to better understand “how risks map across countries, and how spillovers can quickly spread across sectors to expose domestic vulnerabilities.”

In a statement accompanying the new growth forecasts, Blanchard warned of complacency.

“These risks should not be overplayed, but policy makers clearly must be on the lookout,” he said. “Macroprudential tools are the right instruments to mitigate these risks; whether they are up to the task, however, is an open question.”

Geopolitical Risks

The IMF said it is expecting a recession in Ukraine and stagnation in Russia in 2014, with the effects waning in 2015 and beyond. The effect could be broader if natural-gas and crude-oil markets are disrupted, according the fund.

In the Middle East, the IMF anticipates severe effects of military strife in Iraq and Libya. Oil prices could rise sharply if crude production is disrupted, the fund said.

Blanchard said the world economy faces a balancing act.

“On the one hand, countries must address the legacies of the global financial crisis, ranging from debt overhangs to high unemployment,” he said. “On the other, they face a cloudy future. Potential growth rates are being revised downward, and these worsened prospects are in turn affecting confidence, demand, and growth today.”

It is not unusual for the IMF’s forecasts to change. Since it first publicly projected 2014 growth in January 2013 with an estimate of 4.1 percent, it has revised its forecast seven times, leading to today’s projection of 3.3 percent.

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