G7 to weigh global response to credit crisis

TOKYO (Reuters) - Financial leaders from the world's richest nations stood ready to discuss a global policy response to the credit crisis, which has unleashed economic downdrafts and market turbulence that knows no borders.

Aggressive action by the United States to cut interest rates and taxes to ward off recession has tested the limits of cooperation in the Group of Seven.

A question of how far other major economies should follow has provided a tense backdrop for finance ministers and central bankers as they gather in Tokyo to seek ways to repair damage to their economies and financial markets wrought by the U.S. subprime mortgage crisis.

But officials arriving on Friday for G7 meetings this weekend showed a readiness to begin tackling problems together.

"The first priority is to act on an international, global basis. The second is to act on a European basis and the third on a national level," German Finance Minister Peer Steinbrueck said.

A draft of the finance leaders' communique, obtained by Reuters ahead of its release on Saturday, said the G7 saw heightened risk and growth moderating in key economies.

"We will continue to watch developments closely and remain committed to taking necessary action, individually and collectively, in order to secure stability and growth in our economies," the draft read.

This follows European Central Bank President Jean-Claude Trichet softening on Thursday his anti-inflation stance and stressing the high levels of uncertainty caused by financial market turmoil and risks to the euro-zone economy.

Markets read this as a sign that the ECB was now willing to follow fellow central bankers in cutting interest rates if needed to prevent a damaging downturn. The U.S. Federal Reserve, Bank of England and Bank of Canada have all eased monetary policy.

But Steinbrueck cautioned that steep interest rate cuts can fuel the very instability they seek to cure.

"I admit that concerning the very sharp rate cuts in the United States, I sometimes wonder whether that could lead to excess liquidity in the next few years. But my conclusion is that it was right to create greater liquidity and build trust."

HEALING DIVISIONS

Ahead of the Tokyo gathering, analysts had worried the G7 club faced dangerous divisions over how to calm turbulent markets and ease fears of a worldwide slump from the credit crisis, with Europe and Japan unwilling to join in aggressive stimulus programs.

The past month has seen 1.25 percentage points in Fed rate cuts plus a $150 billion fiscal package to tackle credit problems from the subprime crisis. Whether this is enough to rescue the U.S. economy and avert a worldwide economic slump remains very much in question.

U.S. Treasury Secretary Henry Paulson sought to reassure on that front, saying the U.S. economy is fundamentally healthy.

"I still believe that we are going to continue to grow, although at a slower pace for a while. But the risk is very much to the downside," he told Japan's NHK television.

The G7 financial leaders are not expected to break any new ground on currency rates at this meeting.

Rather, financial upheaval was in the forefront of ministers minds as they arrived for the Tokyo G7 meeting.

"We will hold frank discussions regarding the subprime impact on financial markets and the global economy," said Japanese Finance Minister Fukushiro Nukaga.

COORDINATION SOUGHT

Steinbrueck, in a letter to G7 finance ministers, called on his colleagues to address financial market problems.

"Prompt and coordinated action by central banks has helped to ease the immediate problems. Yet the full impact of the subprime crisis on the financial sector is yet to be known," he wrote in the letter seen by Reuters.

He said political responses were needed to strengthen risk management, bank capital and transparency in financial markets.

The Financial Stability Forum, a group of central bankers and other regulators studying the subprime mortgage problem and market upheaval, is due to deliver an interim report to the G7 policymakers.

But it was the willingness of central bankers to provide monetary easing that pleased politicians.

"I was pleasantly surprised on reading the declaration of Mr. Trichet," said French Economy Minister Christine Lagarde.

Russian Finance Minister Alexei Kudrin said policymakers must work together to find solutions to the credit shortage.

"Coordination of efforts may soften the consequences of such crises, first of all a coordination of efforts between central banks on their refinancing rates because this is the key factor supporting the financial system," Kudrin told reporters in Moscow before heading to Tokyo.

British Finance Minister Alistair Darling, however, played down the prospect of coordinated steps to boost global growth.

"The first thing is that conditions in different countries are not the same," he said.

Whether emerging economies can come through the U.S. shakeout relatively unscathed will be on the agenda when G7 officials meet with finance ministers of China, Indonesia, South Korea and Russia for dinner on Saturday.

The head of the Asian Development Bank, Haruhiko Kuroda, said on Friday fiscal stimulus could be an option for emerging Asian economies if global growth slows further but the main concern for now is to contain inflation.

(Additional reporting by Yoko Nishikawa, Brian Love, Glenn Somerville, Gavin Jones and Sophie Hardach in Tokyo, David Lawder in Washington and Gleb Bryanski in Moscow; Writing by Stella Dawson; Editing by Rodney Joyce)