G-8 Plans to Reverse Stimulus as Rebound Signs Grow

By Simon Kennedy and Rainer Buergin

June 15 (Bloomberg) -- 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 $2 trillion in stimulus packages.

“Growth should remain the principal focus of policy,” U.S. Treasury Secretary Timothy Geithner said after the meeting ended on June 13. “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 U.S. 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 Inc. in Vineland, New Jersey, which oversees $1 billion in assets. “They worry that inflation is going to build up if nothing is done to withdraw the stimulus.”

Dollar Support

The G-8’s statement made no reference to currencies or interest rates given the absence of central bankers from the meeting.

Treasuries rose for a third day and the dollar gained the most in a week against the euro today after Russian Finance Minister Alexei Kudrin told Bloomberg Television he has full confidence in the U.S. currency. Russia’s central bank drove U.S. 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 percent.

“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 percent climb against the dollar in the past four months.

Upbeat Reports

The G-8 ministers delivered their most upbeat outlook since the collapse of Lehman Brothers Holdings Inc. in September amid mounting evidence that the deepest global recession in six decades is moderating.

Economists expect reports on U.S. housing and German investor sentiment to back that case in coming days.

Home Depot Inc., the world’s largest home-improvement chain, said June 10 that fiscal 2009 profit may decline less than it had projected. Virgin America Inc., 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. European industrial production dropped by a record in April and Volkswagen AG, Europe’s largest automaker, said June 12 that “very weak” global car markets aren’t yet recovering.

There are “signs of stabilization,” though “the situation remains uncertain” as climbing unemployment and volatile commodity prices present obstacles, the ministers said in their statement.

No Exit Talk

Geithner and U.K. 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 U.S. 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.”

Canadian Critic

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 U.S. 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 U.S., Japan, Germany, France, U.K., Canada, Italy and Russia. Its ministers met to shape an agenda for their leaders’ meeting on July 8-10 in L’Aquila, the Italian town destroyed by an earthquake in April.

To contact the reporters on this story: Rainer Buergin in Lecce at Rbuergin1@bloomberg.net; Simon Kennedy in Paris at skennedy4@bloomberg.net