G7 to weigh global response to credit crisis

By Sumeet Desai and Gernot Heller

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.