Global economy navigating through political storms

WASHINGTON (Reuters) - A global economy edging toward recession and confronting huge political challenges adds urgency to the G20 summit in Mexico this week for strong world leadership of the kind last seen at the height of the 2007-09 financial crisis.

"The world is facing some very difficult times, economically and financially, socially and politically," said Charles Dallara, managing director of the Institute of International Finance.

"We need once again a global coordinated approach."

Leaders from the 20 industrialized and developing nations, representing more than 80 percent of world economic output, are expected to deliver pledges to stimulate growth while balancing those efforts against steps to rein in budget deficits at a meeting in Los Cabos, Mexico, on Monday and Tuesday.

But there is a sense of pessimism that politicians, after spending more than $1 trillion to stimulate growth - on top of $6 trillion in central bank money printing the past four years - can offer policies sufficiently convincing to restore business and consumer confidence.

Political differences over the future shape of Europe, a U.S. Congress bitterly divided over fiscal policy and a leadership change in China, not to mention political turmoil in Egypt and violence in Syria, will all cast a troubling shadow over the meeting.

"Significantly weaker fiscal positions and entrenched divergences both among governments and within countries mean that achieving even moderate cooperation, let alone any concrete results, at the Los Cabos summit will be a huge - probably insurmountable - task," said Oxford Analytica in a client note.

If politics disappoint and financial market turbulence escalates next week, it will rest on the shoulders of central bankers to restore some calm.

Emergency cash injections, which central bankers stand ready to deliver in case financial market stress becomes extreme after Sunday's election in Greece, would be a stop-gap measure to steady markets and put a floor under confidence.

"If central bankers care about supporting riskier assets, below 1,250 on (the U.S. Standard and Poor's 500 Index) could be considered their intervention zone," said Dominic Konstams, economist at Deutsche Bank.

The benchmark S&P 500 index <.spx>, which closed at 1,342.84, up 1 percent, on Friday, had flirted with that level earlier in June when Greece's political stalemate heightened fears of a euro zone break-up.

More significant would be for central banks to deliver a round of rate cuts or other monetary stimulus to support growth, similar to those announced by the Bank of England last week.

India's central bank, facing an economy growing at its weakest pace in nine years, is expected to lower its refinancing rate on Monday. [ID:nL3E8HC8IS] It would join China and Brazil in easing mode, a marked turn for emerging economies, which until recently were the bright spots powering through the global economic storms unleashed by the financial crisis.

U.S. Federal Reserve Chairman Ben Bernanke also has signaled a readiness to support growth if financial strains from Europe's debt crisis threaten an already weakened U.S. outlook.

The Fed is expected to downgrade its growth forecasts at a meeting on Tuesday and Wednesday, possibly clearing the path for a third round of bond-buying known as quantitative easing, though a Reuters poll found most analysts who expect QE3 do not see it being launched at this meeting.

But political disarray at the G20 summit combined with financial market turbulence could tip the U.S. central bank's hand.

"The Fed response would likely be limited, with further easing only if there is significant collateral damage to the U.S. economy," said Ethan Harris, co-head of global economic research at Bank of America Merrill Lynch.

Economic data this week are expected to underscore the vulnerability of major economies. Markit on Thursday releases its early read on the manufacturing sectors in June for China, the United States and the euro zone. All are likely to show further softening as global demand slows.

U.S. factory output contracted in May for the second time in three months and a regional manufacturing index plunged, auguring ill for Markit's U.S. gauge, which stood at an expansionary 54 in May.

"It's another reminder of the loss of momentum in the U.S. and global economy," Cary Leahy, managing director at Decision Economics in New York said of the latest factory data.

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In the euro zone, analysts forecast that contraction in the factory sector deepened this month to 44.9 PMI reading from 45.1 in May. The service sector also is expected to weaken to 46.4 from 46.7. Anything below 50 indicates a decline in activity.

"Economic growth appears to be lost in a fog of uncertainty," said Mark Vitner, senior economist at Wells Fargo.

The magnitude and complexity of the European Union's effort to rebuild its political architecture in the midst of a financial crisis, plus deep concern over how the United States can put its economic house back in order, make it very hard to navigate toward faster growth.

"The recent change in the tone of key U.S. economic reports and the intensifying financial crisis in Europe have clearly sent chills through policymakers and businesses, particularly those doing a significant part of their business overseas," Vitner said.

(Reporting by Stella Dawson; Editing by Dan Grebler)

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