The global economy is slowly starting to pull out of its deepest recession since World War Two but recovery will be sluggish and policies need to remain supportive, the International Monetary Fund said on Wednesday.

In an update of its World Economic Outlook, the IMF said the global economy is likely to contract 1.4 percent this year, a touch steeper than the 1.3 percent decline it projected in April.

However, it now sees world economic growth picking up to 2.5 percent in 2010, compared to an April projection of 1.9 percent.

IMF chief economist Olivier Blanchard said forces dragging down the economy were easing in intensity but those pushing it up were still weak, despite heavy government spending and central bank lending.

This leads us to predict that while the world economy is still in recession, the recovery is coming but it is likely to be a weak recovery, Blanchard told a news conference.

The IMF said financial conditions had improved more than expected as governments have pumped huge amounts of money into their economies, and warned that withdrawing supportive fiscal and monetary policies prematurely would hurt the recovery.

Although exiting now would be premature, I think it's fundamental that we devise credible plans that map where we're going in the medium-term and how we're going to get there, said Jose Vinals, director of the IMF's Monetary and Capital Markets Department.

He warned against complacency and said there was a danger of a setback if financial markets got too far ahead of economic recovery. Still, he said unprecedented policy intervention had reduced the risk of a systemic collapse.

BELOW-TREND GROWTH AHEAD

The IMF said while the world's advanced economies are expected to recover modestly next year, growth will remain below potential until later in 2010, suggesting unemployment will continue to rise.

It said the U.S. economy will contract 2.6 percent this year, slightly less than it thought in April, with growth resuming in 2010, albeit at a mere 0.8 percent.

The IMF said the euro-area economy would likely shrink 4.8 percent in 2009, 0.6 percentage point more than it had forecast in April. Next year, the IMF said the euro-area would contract 0.3 percent.

Japan's economy is expected to contract by 6 percent this year, with growth resuming slightly to around 1.7 percent next year, while emerging and developing countries are likely to regain growth momentum during the second half of 2009, it said.

Blanchard said Asia cannot decouple from the global economy despite signs the region is emerging from the worldwide slump faster than many economists had expected.

Strong growth, particularly out of China and India had rekindled hopes the region could decouple from slower-growing advanced economies and recover on its own.

The fund said policies should remain supportive until growth resumes and deflationary risks dissipate. Where there is room, central banks should explore cutting interest rates further and signal that they intend to keep them low until a durable recovery is under way, it said.

It said concerns about rising government debt from efforts to shore up economies highlight the need to establish plans to tighten budgets over the medium-term.

Although fiscal policy should stay supportive through 2010, plans should be made for rebuilding fiscal balances and ensuring sustainable debt paths after growth is firmly reestablished, the IMF said.

(Editing by Neil Stempleman)

International Monetary Fund