The recession-hit euro zone will fall further behind a generally improving US and a rebounding Japan this year, the OECD said today, cutting its global growth forecasts.
In its twice-yearly Economic Outlook, the Organisation for Economic Cooperation and Development forecast the world economy would grow 3.1% this year before accelerating to 4% in 2014.
The estimates marked a slightly more pessimistic view after in November the Paris-based think tank forecast global growth of 3.4% this year and 4.2% next year.
The US was seen driving global growth with the world's biggest economy projected to expand 1.9% this year and then accelerating to 2.8% in 2014, which would be the country's best rate since 2005.
In contrast, the euro zone was estimated to remain in recession for a second year. The OECD sees its economy contracting 0.6% in 2013 and then returning to growth next year with a rate of 1.1%.
However, the outlook diverged widely within the 17-nation bloc with regional powerhouse Germany seen achieving growth of 0.4% and rebounding to a rate of 1.9% in 2014.
After years of debt crisis testing the euro zone's capacity to hold together, OECD chief economist Pier Paolo Padoan said that risks to the economic outlook have finally begun to recede. However, he warned that the easing in the euro zone's debt crisis may lead to reform fatigue.
Unlike the US in the 2008-09 financial crisis, the euro zone still needed to tackle problems in its financial sector holding back the flow of credit, he said.
Lifting its estimate for Japan, the OECD said that the central bank's pledge to ramp up its monetary stimulus aggressively would help its economy grow 1.6% this year. The OECD took a more pessimistic view on China, forecasting that its economy would grow 7.8% this year, down from a previous estimate of 8.5%.
With economies in most countries still in recovery mode, the OECD said central banks should keep monetary policies easy while the European Central Bank should even dramatically step up its efforts to get credit flowing to the economy.
The OECD called on the ECB to make banks pay for holding deposits with it and urged it to buy assets such as securitised loans from credit-starved small and medium-sized firms, two options ECB policymakers say they are currently considering.
In the case of the US Federal Reserve, the OECD said it may soon be justified to begin curbing its purchases of government bonds and mortgage-backed securities. However, it warned that a slower pace of purchases would have to be carefully flagged to markets in order to avoid an abrupt sell-off by other investors that might cause yields to spike dangerously higher.
The OECD not only gave its blessing to the Bank of Japan's dramatic increase in monetary surplus but said further moves could be used to boost the economy.
It also noted improvement in Britain's pace of fiscal consolidation in both 2013 and 2014, but repeated the concern mentioned by the International Monetary Fund last week that a Help to Buy programme might end up pushing house prices up.
US interest rates could spike when Fed slows bond buying
After flooding US banks with cash to fight an economic crisis, the Federal Reserve must now find a way to slowly tighten the money spigot without dealing a painful shock to businesses and families, the OECD said in a report today.
The report by the Organisation for Economic Co-operation and Development, a top policy advisory group for the developed world, summed up the bind America's central bank now faces.
Low interest rates have helped the US economy, but could inflate bubbles in the financial market. That suggests the Fed might have to slow down its bond buying programme "in the near future," the OECD said.
The risk is that investors might respond to this by bidding interest rates sharply higher. This would likely hit the stock market and home prices, while also hurting exporters by raising the value of the dollar.
Citing its own economic models, the OECD said that, if rates on long-term government bonds rose 2 percentage points in one year, as they did following an unexpected shift in Fed policy in 1994, the tightening of credit would subtract at least 1.5 points from the country's economic growth rate.
"With possible disruptions to the financial system ... negative effects could be larger," the OECD said.
The OECD said the Fed was likely to manage expectations carefully to avoid letting this happen. "But there is still a risk of a repetition of developments from 1994," it said in today's report.
The Fed has held overnight interest rates near zero since late 2008 and has more than tripled its balance sheet to about $3.3 trillion with a series of bond purchases programs. It is currently buying $85 billion of bonds per month.
In recent weeks, officials at the Fed have made numerous comments about when they might start slowing their purchases and the yield on 10-year U.S. government bonds has risen to its highest in more than a year.
Based in Paris, the OECD provides economic policy advice to the governments of most of the rich world, which fund the organisation. A few developing countries such as Mexico and Chile are also members of the organisation.
In addition to advising the Fed to tread carefully, the OECD criticised Washington's decision to enact sweeping budget cuts in March. The report said the government's austerity would hold economic growth to 1.9% this year, just below a projection made in November and down from 2.2% in 2012.
