Trichet warns economy is not out of the woods

The risks of of "sudden emergence of unexpected financial turbulence" could push the world economy even further into recession, according to the president of the European Central Bank.

"We are still in the downturn phase – a downturn that globally is proving to be the deepest since the Second World War," Jean-Claude Trichet said. "While there are first signs the pace of economic weakening is decelerating, we must remain alert. We are in uncharted waters."

His remarks came as the World Bank said the global economy will shrink 2.9 per cent in 2009, a downgrade from its previous forecast for a 1.7 per cent contraction, as the world’s financial institutions continue to try to repair their balance sheets.

The world economy is expected to grow by 2 per cent in 2010 and by 3.2 per cent in 2011.

The World Bank warned that some $1.2 trillion in external debts run up by emerging economies in eastern Europe, central Asia and elsewhere will soon need to be re-financed, placing strain both on those nations and on the western banks with exposure to them.

It said: “Although extraordinary policy responses by governments around the world have helped save the global financial crisis from systematic collapse, they have not, thus far, closed the negative feedback loop between financial instability and economic recession.”

Growth in developing countries is expected to stay positive but will slow from 5.9 per cent in 2008 to 1.2 per cent this year. The World Bank added: “The reversal of capital flows, the collapse in stock markets, and the general deterioration in financing conditions have brought investment growth in the developing countries to a halt.”