WASHINGTON Talk of the euro zone splintering is "crazy" and European leaders need to quieter their dissonant voices which are destabilizing financial markets and threatening to tip the region back into recession, the International Monetary Fund warned on Tuesday.
The European Union should quickly implement its bailout fund for troubled countries and, in the meantime, the European Central Bank should continue its bond-buying program, it said.
The ECB also should stand ready to lower interest rates if the economic conditions deteriorate further, the IMF said in releasing its World Economic Outlook.
The sharp comments from the global lender sought to galvanize European leaders around an action plan as finance ministers and central bankers arrive in Washington this week for the annual IMF, World Bank and G20 meetings to assess the global economic outlook.
The IMF repeated its call for a stabilization of Europe's financial system via new capital injections -- first by the private sector and then through public measures if necessary -- to insulate banks from the loss of confidence in the value of their euro zone government debt holdings.
The urgency of halting the spreading fears of euro zone collapse on the back of Greece's debt woes was underscored by fresh growth forecasts released by the IMF.
Euro zone growth has virtually stalled and is forecast at 1.1 percent for 2012, the IMF said.
Moreover, risks are to the downside, and policy missteps could easily trip up the region, the IMF said. Issuing euro bonds to help out troubled countries would offer no quick fix unless Europe first creates oversight mechanisms, it said.
The IMF's message was that Europe has the financial capacity to handle its problems and prevent a slide back into recession if it can exercise sufficient political will.
Markets were spooked by suggestions from officials in German Chancellor Angela Merkel's coalition that Greece might default on its debt and leave the euro zone. The Dutch finance ministry also said it was examining Greek default.
Carlo Cottarelli, IMF director of fiscal affairs, warned this "cacophony of voices" sows fear and uncertainty over how Europe is managing the crisis, undermining confidence in the outlook.
"That is not taken well by markets and this is a problem that needs to be addressed," he said.
The IMF dismissed talk that Greece is headed toward a sovereign debt default and an exit from the euro zone.
"It is a problem that is eminently manageable if the right actions are taken," Jorg Decressin, senior IMF economist. Decressin said. "And so I still think it's a crazy proposition to think about a break-up of the euro area."
IMF officials side-stepped questions over whether Greece has implemented enough of its fiscal austerity program to merit release of the next 8 billion euros of its EU/IMF loan program to prevent debt default, noting that talks are ongoing.
But in general, it sounded comfortable with progress by most euro zone periphery countries on deficit reduction, and said the Greece situation should not spur a further crisis.
IMF officials declined to comment directly on Standard & Poor's downgrade of Italy's sovereign debt rating to A from A+ on Monday and to raise the possibility of a further cut.
Instead they expressed satisfaction that Italy's latest budget plan puts the euro zone's third-largest economy onto a trajectory that lowers its debt and deficit levels.
Its fiscal deficit of 4 percent already compares relatively favorably with other advanced economies, and its budget should bring the level to around 1 percent by 2013, Decressin said.
Although that falls short of the balanced budget that Italy projects -- the IMF expects weaker growth -- it would still place Italy's deficit substantially below those of other major economies, he said.
As for Italy's total debt-to-GDP ratio, the IMF projects it would start declining in 2013, and by 2016 would be slightly below that of the United States, he said.
Additionally, Italy's population already is relatively old so aging costs are not forecast to increase as fast as in many other advanced economies, and it has already cut pensions.
"So you might wonder what is the problem then, with Italy? And the issue here is the growth rate, which is relatively low," Decressin said.
This requires structural reforms to its labor, goods and services markets to raise output alongside fiscal consolidation and for the government to implement its austerity plans.
As for switching to stimulus in countries that have stronger deficit-to-GDP profiles, the IMF recommended against that. Germany and Britain should retain their fiscal restraint and only switch course if growth threatens to slow substantially, which is not expected. Currently, Decressin said he sees no reason for them to change fiscal course.
(Editing by James Dalgleish)