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Retreating U.S. stimulus poses risk to world recovery

The facade of the U.S. Federal Reserve building is reflected on wet marble during the early morning hours in Washington, July 31, 2013.REUTE
The facade of the U.S. Federal Reserve building is reflected on wet marble during the early morning hours in Washington, July 31, 2013.REUTE

By Robin Emmott

BRUSSELS (Reuters) - The world economy should finally overcome its hangover from the global financial crisis this year as growth picks up and house prices rise, but reduced U.S. monetary stimulus will pose a challenge.

After months of angst, investors will see how the U.S. Federal Reserve handles its decision to curtail its policy of easy money, starting from this month.

U.S. jobs data on Friday will give markets a sense of the pace at which the Fed plans to pare back its bond-buying program, while minutes on Wednesday from its December 18 meeting will throw light on the central bank's thinking.

"The United States will be the main focus given the Fed has finally started to taper its asset purchases," said James Knightley, a senior economist at ING in London, referring to what economists call the "tapering" of U.S. stimulus.

"Nonetheless, the Fed has made it clear that it will not be looking to run down the size of its balance sheet anytime soon, while rate hikes remain some way off," he said.

The Fed's stimulus revived the U.S. economy after the biggest crisis since the Great Depression and the U.S. economy is leading the global recovery. The United States could grow by up to 3 percent this year, helping the global economy to expand by almost 4 percent, according to the International Monetary Fund.

The delicate job of bringing the $85 billion-a-month program gradually to an end will almost certainly fall to Janet Yellen, whose candidacy as the next Fed chair will be voted on by the U.S. Senate on Monday.

Yellen, who would become the first woman to chair the U.S. central bank, would take the reins on February 1, the day after Ben Bernanke ends his two-term stint.

CURRENCY CONCERNS

For emerging markets - major beneficiaries of cheap money unleashed by Fed stimulus - a scaling back of the program will prompt investors to reduce their holdings of stocks and bonds. Short-term economic growth could suffer due to a failure to reform during the years of easy money.

Turkey is one country that relies on foreign capital to plug holes in its balance of payments and the country will be in focus again in the week ahead, not least because Ankara faces its greatest period of political instability in a decade.

Markets have calmed since the last week of 2013, when Prime Minister Tayyip Erdogan dismissed police officers involved in a corruption investigation that has dragged in relatives of ministers and others with close links to the government.

But a falling lira is saddling companies with higher payments on foreign loans and pushing up inflation.

Indonesia, also vulnerable in the face of reduced U.S. stimulus due to its sizeable current account deficit, has been at the centre of the sell-off in emerging currencies and will hold a central bank policy meeting with the Fed firmly in mind.

Emerging markets are becoming more of a concern for the global economy as the rich world recovers from the 2008/2009 financial crisis, while China's slowing economy, which generates more than a third of global growth, has added to the unease.

The world's second-largest economy releases business surveys, trade, inflation and lending figures in the week ahead.

NO CELEBRATION

Europe offers good news for a change and U.S. Treasury Secretary Jack Lew should hear some of that in a visit to Berlin, Paris and Lisbon for talks with senior officials.

The single currency area is forecast to return to growth in 2014 after two years of contraction and Greece, at the centre of the bloc's crippling banking and debt crisis, expects its first economic expansion in six years.

Still, European Central Bank President Mario Draghi will be in no mood for celebrating when the bank's Governing Council meets on Thursday. He faces the difficult task of supporting growth with limited tools in a region still facing record unemployment and high public and private debt levels.

The ECB is banned from buying bonds directly from governments and cannot emulate the Fed, although it can find ways to purchase bonds from banks on the secondary market.

Draghi said last week he saw "no need for immediate action" after cutting interest rates to a record low of 0.25 percent in November, and sees signs of a gradual economic recovery.

"Draghi will merely emphasize once again that the ECB is ready to act," said Michael Schubert, an economist at Commerzbank in Frankfurt.

Before the ECB meets, euro zone inflation data on Tuesday will show how consumer prices are holding up despite deflationary risks in some of the weaker economies.

Surveys of the euro zone's service sector are likely to show the currency bloc ended the year on a reasonably robust note, even if France's tepid performance is a concern.

Outside the euro zone, Britain is in a different position, with growth picking up, unemployment falling and house prices rising, leading to talk of the need for a rate rise sooner rather than later to avoid a real estate bubble.

The Bank of England also holds its meeting on Thursday but no one expects a change in monetary policy this month. For the time being, the consensus remains that rates will rise from their record low of 0.5 percent in 2015.

(Editing by Susan Fenton)

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