(FT) -- The risk of a slowdown in the global economic recovery has risen sharply, but governments should continue planning to tighten fiscal policy, the International Monetary Fund has said.
Updates to the IMF's regular world economic outlook and assessment of global financial conditions, released on Thursday, said jitters in financial markets in May and June threatened confidence and growth worldwide.
"In the near term, the main risk is an escalation of financial stress and contagion, prompted by rising concern over sovereign risk," the world economic outlook said.
"This could lead to additional increases in funding costs and weaker bank balance sheets and hence to tighter lending conditions, declining business and consumer confidence, and abrupt changes in relative exchange rates".
The IMF did not change its forecast for 2011, regarding these problems as a threat rather than a central projection. But it warned that the stress in financial markets would pose difficult challenges for policymakers.
"Potential downside economic risks and the strains in interbank and sovereign markets have complicated exits from the extraordinary fiscal, monetary and financial policies initiated some months ago," the report said. The fund was one of the first big economic institutions to call for fiscal stimulus to help the world economy ride the storm created by the credit crunch in 2007-2008.
But in recent months it has fallen into line with many others, including the World Bank and the Organisation for Economic Co-operation and Development, in emphasising fiscal consolidation rather than keeping the public spending taps open.
"Most advanced economies do not need to tighten before 2011, because tightening sooner could undermine the fledgling recovery, but they should not add further stimulus," it said.
The IMF called for most governments in advanced economies to use monetary rather than fiscal policy as the "first line of defence" to any weakening in demand, in spite of the fact that interest rates across much of the industrialised world are near zero.
It also urged the European Central Bank to give stronger signals to the bond markets that it was prepared to intervene if necessary to boost liquidity.
