OECD fears euro woe to snap brittle world recovery

PARIS (Reuters) - The United States and Japan are leading a fragile developed world recovery that could be blown off course if Europe fails to contain the damage from its problem debtor states, the OECD said on Tuesday.

It urged euro zone leaders to embrace all options for tackling the crisis, potentially including common bonds to go with the common currency.

In its twice-yearly economic outlook, the Paris-based Organisation for Economic Co-operation and Development forecast that global growth would ease to 3.4 percent this year from 3.6 percent in 2011, before accelerating to 4.2 percent in 2013, in line with its last estimates from late November.

"The global economic outlook is still cloudy," OECD Secretary General Angel Gurria told reporters.

"At first sight the prospects for the global economy are somewhat brighter than six months ago. At closer inspection, the global economic recovery is weak, considerable downside risks remain and sizeable imbalances remain to be addressed."

Growth across the organization's 34 members, generally the wealthiest in the world, would ease this year to 1.6 percent from 1.8 percent in 2011 and then reach 2.2 percent in 2013, the OECD said, also roughly in line with previous estimates.

Gurria said that public finances were "fragile", and in some cases "in dire straits", in OECD countries.

A perception that the burden of the economic crisis had not been fairly shared was fuelling a confidence crisis and European leaders should consider all possible measures to mend the bloc's debt problems.

"A bad outcome scenario in the euro area with implications for the rest of the world cannot be ruled out," he said.

Piling pressure on euro zone leaders on the eve of an informal summit focused on boosting growth, Gurria said Europe could only solve its debt crisis if it stays open to all options, including ideas like euro zone bonds, which are a taboo for Germany.

"You have to put all the instruments on the table," Gurria said. "We have to overshoot... If the market is waiting for 50 (ideas) then put 100 on the table."

EURO GLOOM

The OECD forecast that the 17-member euro zone economy would shrink 0.1 percent this year before posting growth of 0.9 percent in 2013, though regional powerhouse Germany would chalk up growth of 1.2 percent in 2012 and 2.0 percent in 2013.

"We see a slow rebound of growth in the United States driven mostly by private demand, some pick-up in Japan and moderate to strong growth in emerging economies," OECD chief economist Pier Carlo Padoan told Reuters in an interview.

"We also see flat growth in the euro area which hides important differences, with northern countries growing and southern countries in recession," he added.

Although OECD economies were on the mend, the euro crisis could still spiral out of control with Greece struggling to remain solvent and Spanish banks needing to be recapitalized, Padoan said.

The European Central Bank's injection of one trillion euros ($1.3 trillion) of liquidity into the euro zone's banking system and an increase in European bailout funds and IMF reserves had helped keep the bloc's crisis from spiraling out of control.

"If the situation gets worse, there are ways to enhance the firewall capacity which could include a stronger intervention or role of the ECB," Padoan said.

In particular, the ECB should not rule out buying government bonds again to keep borrowing costs down, lending to the ESM European bailout fund and cutting its benchmark interest rate, which currently stands at 1.00 percent. The ECB could also consider another injection of liquidity into the banking system.

Additionally, the time was ripe to begin thinking about introducing bonds jointly underwritten by euro nations to fund projects and possibly bank recapitalizations, Padoan said amid growing concerns that Spain's banks in particular are short of sufficient capital.

New French President Francois Hollande is eager for the euro area to begin talking seriously about such bonds at a dinner summit on Wednesday focused on how to revive growth in the bloc.

But Germany remains deeply opposed to the idea out of concern it would be tantamount to wealthy countries footing the bill for countries that overspend in the absence of more oversight of fiscal policy from the EU level.

"The reason euro bonds are seen by some as a problem rather than a solution is because this is the old problem of Europe, mutual trust is not strong enough," Padoan said. "We have to be very serious and ask ourselves which the institutions are that could guarantee enough mutual trust to think of ourselves as one, not as a group of countries."

U.S., CHINA ENGINES

In contrast to the euro zone, the United States was expected to continue to benefit from easy credit conditions and ultra-loose monetary policy, its economy forecast to grow 2.4 percent this year and 2.6 percent in 2013. In November, the OECD had forecast 2.0 percent for 2012 and 2.5 percent for 2013.

Although some budget tightening and a still weak housing market would be a drag on growth, private sector demand would continue to strengthen as the unemployment rate eased to as low as 7.5 percent by the end of 2013 from 8.1 percent in April.

The OECD said that while the United States needed to step up the pace of its fiscal tightening, if tax cuts were allowed to expire as scheduled in 2013 it could threaten growth.

Japan's economy was set to grow 2.0 percent this year and 1.5 percent in 2013 as a reconstruction boom after last year's earthquake and tsunami faded, although recovering world trade would offer support.

A rebound in global trade would be a bright spot for many economies, with the OECD forecasting a surge from 4.1 percent growth this year to 7.0 percent in 2013.

Export giant China was forecast to grow 8.2 percent this year and 9.3 percent in 2013 as interest rate cuts and increased social spending propped up domestic demand in the economy, which is not an OECD member. ($1 = 0.7832 euros) ($1 = 0.7832 euros)

(Reporting by Leigh Thomas; Editing by Jeremy Gaunt)

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