Fitch Ratings warned today that continuing imbalances within and between the world’s largest economies are increasing the risk of a sharper downturn in global growth and a potentially destabilizing correction in asset prices.

Fitch notes in a new report that as much as half of the reduction in emerging market credit spreads since the beginning of 2000 could be accounted for by low U.S. interest rates and greater risk appetite amongst investors, “suggesting that a marked change for the worse in the global economic environment could quickly and materially adversely impact emerging markets’ access to and cost of borrowing from international capital markets”.

Fitch has cut its forecast for euro area growth from 2% to 1.5% for 2005 but with the U.S., Japan and China expected to continue to enjoy relatively strong growth, the global economy is forecast to still expand by 3% this year, albeit down from last year’s near record of 4%. Concerns about the sustainability of global growth and the risk of a ‘hard landing’ have been exacerbated by continuing imbalances between the world’s major economies; uncertainty over the outlook for the Chinese economy and the U.S. dollar; and the weakening of activity in the euro area.

It says an acceleration of structural reforms in Europe, combined with an appreciation of Asian currencies against the dollar, would help smooth the downward adjustment of the U.S. current deficit. But with oil prices staying high and the U.S. economy continuing to outpace the rest of the world along with little progress being made in cutting the U.S. fiscal deficit, the U.S. current account deficit is forecast to approach US$800 billion this year, equivalent to more than 6% of its gross domestic product.

“Despite the recent gloom, the global economy is still expected to grow in line with its trend rate of around 3% this year. But the risks of a hard landing are increasing so long as Europe delays economic reform and the U.S. tackling its budget deficit,” says Lionel Price, Fitch’s chief economist.

Fitch is also worried that the rejection of the European Constitutional Treaty in recent French and Dutch referenda could mark the end of E.U. enlargement, which has been a powerful force for economic and political reform and stability across the continent, though it still expects Bulgaria and Romania to join the E.U. in January 2007.

Fitch’s assessment of emerging markets, as a whole, is that they are much better placed now to absorb a more severe downturn of the world economy than they were a decade ago. “Indeed, the share of emerging market sovereigns with investment grade status now exceeds 40% – on the eve of the Asia crisis it was less than 10% – underpinned by more robust policy regimes and record levels of international reserve holdings,” it notes. “Though the ratio of sovereign upgrades to downgrades has moderated in the first half of this year to two to one, 13 sovereigns have a Positive rating Outlook compared to 3 with a Negative Outlook, suggesting that sovereign creditworthiness continues to improve despite the more uncertain global economic environment.”