G7 leaders vow cooperation as global econ worries rise

( Reuters ) - Finance leaders from the world's richest nations pledged on Saturday to work together to stabilize world financial markets shaken by the U.S. housing debacle that is puncturing global economic growth.

The Group of Seven finance ministers and central bank chiefs took on a somewhat more conciliatory tone than they had in the days leading up to the meetings, acknowledging that they all had a vested interest in shoring up the global financial system.

"Where coordinated action is found to be necessary, we will do all that is needed," British finance minister Alistair Darling said in a Financial Times interview. "We are all after the same thing and this is to restore stability."

U.S. Treasury Secretary Henry Paulson struck the same theme, urging banks to take losses and raise capital quickly to stave off a credit crunch.

"The worst thing is if they don't raise capital, if they shrink their balance sheet and then restrain their lending," Paulson said in an interview with Japan's Nikkei newspaper.

Pledges to work together to restore the financial system to health contrasted with divisions over fiscal and monetary policy ahead of the G7. Before Saturday's meetings, many in Europe had privately expressed alarm over the U.S. Federal Reserve's aggressive interest rate-cutting stance after it slashed 1.25 percentage points off of the benchmark federal funds rate in less than 10 days in January.

The monetary easing along with a $152 billion U.S. fiscal stimulus package threatened to open a rift between the United States and its allies over how to prevent the credit crisis from pushing the world into a downturn.

But tensions eased after the European Central Bank stressed the risk to euro zone economic growth, alongside its long-held worry about inflation, that sent a signal that the ECB may soon join the Fed, Bank of England and Bank of Canada in cutting rates.

European leaders were particularly concerned about the strength of the euro currency, which has soared against the dollar since the Fed began its cutting rates in September. However, the currency retreated after the ECB's change of heart.

French Economy Minister Christine Lagarde said she welcomed that change by the ECB, but wanted more.

"It's like the overture of a symphony: you are always waiting for what comes next," she said.

With the more pressing matters to discuss -- namely the health of the U.S. and global economy - foreign exchange issues were expected to remain on the back burner at Saturday's meeting. A G7 source said the closely watched communique, issued after G7 meetings, would include broadly the same wording on foreign exchange as it had previously.

As before, the communique was likely to put emphasis on the need for China to allow its yuan currency to appreciate more quickly. Many G7 leaders think the weak yuan gives China an unfair trade advantage, and have called on Beijing to step up domestic investment to help rebalance the world economy.

Finance leaders were expected to discuss how best to prevent a repeat of the financial market turmoil that began last summer after a spike in defaults among U.S. subprime mortgage borrowers. Banks have since written off more than $100 billion in bad debts that were tied to those souring home loans, and more write-offs are expected in the coming months.

France's Lagarde said that her U.S. counterpart Paulson expressed grave concern about the state of the U.S. housing market, which has not only left gaping holes on banks' balance sheets but also constrained consumer spending, the lifeblood of the U.S. economy.

She said Paulson did not use the word "recession".

Many U.S. economists, including former Fed Chairman Alan Greenspan, believe the U.S. economy is already in or near a recession. Paulson has insisted that while U.S. growth will slow, a severe downturn is unlikely.

In a draft of their communique obtained by Reuters ahead of its official release later on Saturday, the finance leaders warned of heightened risk to the global economy and moderating growth in key countries.

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