By Lesley Wroughton
WASHINGTON (Reuters) - The International Monetary Fund on Tuesday trimmed projections for global economic growth for this year and next to take into account sharp government spending cuts in the United States and the latest struggles of recession-stricken Europe.
While it said economic prospects had improved in recent months with a fading of financial risks, it warned Europe against relaxing efforts to combat its debt crisis given the messy bailout in Cyprus and a political stalemate in Italy.
The IMF raised its forecast for Japan, welcoming the Bank of Japan's aggressive new monetary stimulus, which it said would boost growth and help vanquish deflation.
"While some tail risks have decreased it is not time for policymakers to relax," IMF chief economist Olivier Blanchard told a news conference to discuss the World Economic Outlook.
The report was released as global financial leaders gathered for the semiannual meetings of the IMF and World Bank later this week.
The IMF cut its 2013 forecast for global growth to 3.3 percent, down from its January projection of 3.5 percent. It also trimmed its 2014 forecast to 4.0 percent from 4.1 percent.
A more subdued outlook for the United States and for the euro zone led it to lower its growth forecast for advanced economies to 1.2 percent for 2013 while it kept its 2014 forecast at 2.2 percent.
While it lowered its projections for growth in emerging economies to 5.3 percent for this year, it also said growth was already accelerating and would hit 5.7 percent in 2014. Growth has returned to a healthy pace in China and activity is expected to recover in Brazil next year, the IMF said.
Strong domestic demand in sub-Saharan Africa should help boost growth in both resource-rich and poorer economies in that region, the Fund added. Meanwhile, growth in the Middle East and North Africa is likely to dip this year as oil production slows in some oil-exporting nations and "Arab Spring" countries struggle with political transitions.
"Notwithstanding old dangers and new turbulence, the near-term risk picture has improved as recent policy actions in Europe and the United States have addressed some of the gravest short-term risks," the Fund said.
BOJ ON TRACK BUT NEEDS HELP
Blanchard said the dramatic overhaul of monetary policy announced by the Bank of Japan was a necessary step and he hoped it would succeed.
The IMF said inflation in Japan would likely rise above zero in 2013 and temporarily jump in 2014 and 2015 in response to an increase in consumption taxes.
The Bank of Japan unleashed an intense burst of monetary stimulus earlier this month, pledging to inject about $1.4 trillion into the economy in less than two years, a major shift from its previous incremental steps.
Tokyo came under fire before a meeting of officials from the Group of 20 leading economies in February for comments that suggested it was targeting specific levels for the yen with its easing of monetary and fiscal policy. The yen last week hit a four-year low against the dollar.
But the IMF said it found "no large deviations of the major currencies from medium-term fundamentals" and dismissed talk of a "currency war" as overblown.
"We think it is a logical consequence of appropriate monetary policy," Blanchard said when asked about the yen's sharp decline.
The Fund said the U.S. dollar and euro "appear moderately overvalued" and the Chinese renminbi "moderately undervalued." Evidence on the value of the yen "is mixed," it added.
FIRST FED RATE INCREASE IN 2016
The IMF said Europe and the United States had dodged bullets by enacting policies that laid to rest the notion of a euro zone breakup and the possibility the world's richest economy would fall off a "fiscal cliff" of tax increases and budget cuts.
However, it suggested an easier monetary policy might be warranted in the euro zone.
"Given moderating inflation pressure, monetary policy should remain very accommodative. Room is still available for further conventional easing, as inflation is projected to fall below the European Central Bank's target in the medium term," it said.
The IMF forecast economic contractions in France, Spain and Italy this year. IMF economist Jorg Decressin said Italy's economic policy was on the right track and prospects would brighten next year with less need for government spending cuts. He also said fiscal policy in France is "appropriate" even if the country misses the goal to trim the deficit below an EU ceiling of 3 percent of GDP in 2013.
The Fund also made clear that, while a worst-case outcome had been avoided, fiscal policy in Washington had tightened more than it had expected - a key reason for its forecast downgrade.
It said across-the-board spending cuts known as the "sequester" would shave about 0.3 percentage points from gross domestic product this year, the IMF said. If the sequester continued into the next fiscal year, it could trim another 0.2 percentage points from GDP growth, the IMF added.
Blanchard said without fiscal consolidation, U.S. economic growth would probably be between 1.5 percent to 2 percent higher this year.
As for U.S. monetary policy, the IMF said it expects the Federal Reserve to hold interest rates near zero into early 2016, although it cautioned that the Fed may need to tighten policy earlier "should upside risks to growth materialize."
The Fed last month maintained a controversial program of buying $85 billion of bonds a month, while pledging to keep interest rates near zero at least until unemployment falls to 6.5 percent, so long as inflation stays under 2.5 percent.
The Fund said developing a comprehensive medium-term deficit reduction framework that reformed so-called entitlement programs and raised additional revenues should be the top priority for the United States.
"Such a comprehensive plan should place fiscal consolidation on a gradual path in the short term, in light of the fragile recovery and limited room for monetary policy," the IMF added.
(Additional reporting by Alister Bull and Jason Lange; Editing by Tim Ahmann and Andrea Ricci)