LECCE - Germany will press G8 finance ministers to start working on how to return policy to normal after months of crisis at a meeting in Italy on Friday, although hopes the world economy has turned the corner are still fragile.
European bank stress tests, exit strategies from crisis mode and reforming how financial markets are regulated will top the agenda for ministers, aiming to prepare for a summit of G8 leaders in early July.
With central bank representatives not attending, officials have said the meeting will not formally address currencies, although financial markets will look for comments from policymakers the weaker dollar, soaring bond yields and oil prices.
Forecasts prepared for the meeting by the International Monetary Fund offered more hope that the global economy will start to recover soon, upping its prediction for global growth next year to 2.4 percent from 1.9 percent, a G8 source said.
Given such signs, German officials say the world's leading powers must look at how they will begin to withdraw huge fiscal and monetary stimulus that will eventually risk destabilising economies again with higher inflation.
As soon as the economy has found its footing again, expansive impulses must be rolled back. And that also concerns monetary and fiscal policies, Deputy Finance Minister Joerg Asmussen told a briefing just before leaving for Lecce.
Data from China showed factory output growth rebounded more than expected in May, alongside stronger expansion in credit and consumer spending, but signs from Germany and France were less optimistic -- showing wholesale and consumer prices falling.
A European G7 source said the timing of an exit strategy is crucial but it was important for officials not to jump the gun.
What is important is that when you start withdrawing the stimulus, it is done quickly and substantially, so you need to be prepared, the source told Reuters.
There are risks to doing it too late and also to doing it too quickly. Now is not the time because you will only worsen things if you begin while the economy is still falling.
Russia weakened the dollar this week by declaring it would reduce its holdings of U.S. government bonds as part of a shift to provide more funds to the IMF and put more of its $400 billion (244.5 billion pound) currency reserves back into the banking sector.
The weaker dollar -- largely the result of the huge rise in public borrowing needed to combat the banking crisis -- is of increasing concern to the Europeans, who worry it could hurt their exports and threaten to destabilise a nascent recovery.
What is damaging for the economy is the volatility of the currency markets and that is why we are keeping an eye on that market, a French official told Reuters in response to a question about recent currency market moves on Thursday.
China -- not attending in Italy -- and Russia may hold the keys to the dollar's fate in the shape of huge foreign exchange reserves invested heavily in the U.S. Treasuries -- seen as among the world's most secure assets.
Russia, however, is tied to the dollar by its dependence on oil, and has stepped up attempts to start a discussion of downgrading the dollar's dominance of reserves, saying it hurts the world economy.
U.S. Treasury Secretary Timothy Geithner will hold separate meetings with his Russian opposite number Alexei Kudrin on Friday, as well as Japan's finance minister Kaoru Yosano and Financial Stability Board chief Mario Draghi.
The dollar inched up after heavy losses earlier this week, but dealers said any move by ministers to talk up the economy would threaten to generate more falls for the greenback.
Ministers will also push on with the sticky process of reform of financial regulation, a commitment made by each of the series of emergency G20 and G8 summits held since the banking crisis deepened last year.
Washington is pushing the Europeans to follow its lead and publish results of stress tests on its banks, and Chancellor Alistair Darling will press for more urgency on clearing up toxic assets and getting banks lending again.
If you don't fix the banking problem, you'll never fix the wider economy, Darling was quoted as saying in an interview in Friday's edition of the Financial Times.
Treasury officials said he will also call on colleagues to make good on pledges they made at the G20 summit in London to deliver more money for the IMF. In particular, Germany and Italy had still not made their bilateral commitments to the IMF clear.
Stress tests of banks in the United States have been made public in a step widely seen as giving greater clarity to investors, but Germany's finance minister Peer Steinbrueck has opposed Europe publishing such results.
French Economy Minister Christine Lagarde favoured publishing stress tests results later this year.
(Writing by Patrick Graham; editing by Toby Chopra)