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Group of Eight finance ministers began drawing up contingency plans for rolling back budget deficits and bank bailouts as the economy shows signs of recovery and investors start worrying about inflation.
Officials meeting in Lecce, Italy, over the weekend said it's prudent to consider what exit strategies to deploy once global growth is secured and asked the International Monetary Fund to examine how to do so without reigniting the two-year crisis. At the same time, they said it's premature to rein back more than US$2 trillion in stimulus packages.
"Growth should remain the principal focus of policy," US Treasury Secretary Timothy Geithner said after the meeting ended on Sunday. "It is too early to shift toward policy restraint."
Policy makers trod a fine line in the knowledge that withdrawing stimulus measures too soon could choke the recovery before it starts, and allowing them to last too long might push up borrowing costs. They are also trying to reassure markets after the yield on the 10-year US Treasury note rose last week to the highest since October.
"Markets aren't looking for specific exit strategies now, but want governments to start thinking about them," said Bill Witherell, chief global economist at Cumberland Advisors. "They worry that inflation is going to build up if nothing is done to withdraw the stimulus."
The G-8's statement made no reference to currencies or interest rates given the absence of central bankers from the meeting.
Treasuries and the dollar may nevertheless find some support after Russian Finance Minister Alexei Kudrin said he has full confidence in the currency.
Russia's central bank drove US bonds and the dollar lower on June 10 by saying it may shift some reserves from Treasuries, pushing the yield on the 10-year security above 4 per cent.
"It's too early to speak of an alternative" to the dollar, Kudrin said in Lecce. IMF managing director dominique Strauss-Kahn said he didn't see a "weak dollar".
German Finance Minister Peer Steinbrueck also said he wasn't concerned by the euro's 10 per cent climb against the dollar in the past four months.
The G-8 ministers delivered their most upbeat outlook since the collapse of Lehman Brothers Holdings in September amid mounting evidence that the deepest global recession in six decades is moderating.
Economists expect reports on US manufacturing and German investor sentiment to back that case in coming days.
Home Depot, the world's largest home-improvement chain, said June 10 that fiscal 2009 profit may decline less than it had projected. Virgin America, an airline partly owned by billionaire Richard Branson, said June 12 its first-quarter net loss narrowed as it filled more seats on planes.
Still, data last week showed the situation is fragile. There was a record drop in European industrial production in April and Volkswagen, Europe's largest automaker, said that "very weak" global car markets aren't yet recovering.
There are "signs of stabilisation", though "the situation remains uncertain" as climbing unemployment and volatile commodity prices present obstacles, the ministers said in their statement. Geithner and UK Chancellor of the Exchequer Alistair Darling were among the most vocal in warning officials not to move too soon. Steinbrueck sought a "credible exit strategy" to avoid inflation.
"We're not there yet," Darling told reporters. "No one is talking about exiting yet."
The officials argued over whether Europe is endangering the rebound by refusing to follow the US and subject its banks to individual and public stress tests. European governments have preferred to examine their financial system as a whole, arguing banks are too diverse to evaluate by a single standard and that publishing results could rekindle the crisis.
"We want stress tests, but stress tests of the system, not related to individual banks," Steinbrueck told reporters in Lecce. "The European banking sector, and the German one in particular, is a lot more heterogeneous than the North American one."
Such resistance drew criticism before the talks from Canadian Finance Minister Jim Flaherty, who said it risked impeding a worldwide revival.
The G-8's statement made no mention of the topic. Flaherty said later that he was "much less frustrated" with Europe's stance after the talks. Italian Finance Minister Giulio Tremonti said the continent may start discussing its approach.
"The uncomfortable truth for Europe is that, however flawed it might have been, the US stress test exercise has so far proved effective in bolstering confidence and helping banks to raise capital," said Marco Annunziata, chief economist at UniCredit Group in London.
The G-8 is composed of the US, Japan, Germany, France, UK, Canada, Italy and Russia.
- BLOOMBERG
