ANALYSIS-G7 unity faces test as U.S. economy falters

PARIS/WASHINGTON (Reuters) - The specter of a U.S. recession is exposing a rift between Washington and the euro zone and testing the limits of global economic policy coordination among the Group of Seven industrialized powers.

As G7 finance ministers and central bank chiefs prepare to meet in Tokyo Saturday, trans-Atlantic tensions have surfaced over everything from currency exchange rates to crisis prevention in financial markets.

What might have been a unifying moment, with leaders from the United States, Japan, Canada, Britain, Germany, France and Italy keen to show a united front in the face of global financial turmoil, is turning out to be nothing of the sort.

Some European officials privately decried what they viewed as an excessive reaction from the United States, which has slashed interest rates and hatched plans to spend almost $150 billion on a stimulus package to prop up the U.S. economy.

The United States countered that it was doing what it must to right the ship, and put the onus on other countries to do their part to sustain global growth.

"Let's be clear. What's just happened is no triumph for G7 cooperation," one euro zone official said, conveying a shared feeling in Berlin, Paris and Rome that Washington was going solo at best and also perhaps dramatizing the economic situation a bit in an election year.

"The Americans reacted on their own, they reacted without any contact at all with their major partners, they reacted in haste and without asking any questions about the impact of their actions on the rest of the world," the official said.

Europe, arguing its own economy is in better shape and not in need of lower interest rates or stimulus, is particularly concerned about the richly valued euro. The currency has soared against the dollar since mid-September when the Federal Reserve began a rate-cutting campaign that has slashed 2.25 percentage points off of the bellwether federal funds rate.

While U.S. and European officials have found little to agree on, there have been some rather unwelcome signs of similarities between their economies.

The services sector in both regions slowed dramatically in January, according to data on Tuesday, and retail sales were disappointingly poor over the crucial holiday shopping season. The euro dropped more than 1 percent during the day to its biggest one-session decline since mid-December as traders decided that European Central Bank rate cut is a growing possibility.

The weakening European economy piles new pressure on the European Central Bank to go down the monetary easing path already taken by the Bank of England, Bank of Canada and U.S. Federal Reserve. So far, the inflation-wary ECB has dug in its heels. Its next policy-meeting is Thursday, and economists widely expect them to hold rates steady again.

"We don't want the burden of (currency) adjustment to have to be borne only by the euro," German Deputy Finance Minister Thomas Mirow said, explaining the euro zone's worries that their exporters are unduly hurt by weakness in the dollar and other currencies.

RECESSION WARNINGS FLASH

Many in Europe had hoped that the G7 meetings this week would be a good opportunity to enlist stronger U.S. support to prop up the ailing dollar and ease pressure on the euro.

However, comments from U.S. officials suggest Europe should not expect anything more than the Treasury Department's well-worn mantra that a strong dollar is in the United States' best interest. In fact, the weakening dollar has helped to boost U.S. exports, one of the few remaining bright spots in the otherwise decelerating economy.

David McCormick, U.S. Treasury undersecretary, said the United States needed swift policy action because of mounting evidence of a pronounced economic slump, and it was time for the rest of the world to step up and help.

"It is especially important that other economies -- large and small, advanced and emerging market -- take prudent steps to strengthen their economies' demand components," he said.

REGULATORY RESPONSE

The two regions have found little common ground on how best to regulate financial markets to prevent a recurrence of the trauma that has rattled the global economy since last summer. What began with rising defaults among U.S. subprime mortgage borrowers quickly morphed into an international mess as banks incurred heavy losses on securities tied to the home loans.

Many in Europe have called for tightening accounting rules, investigating why ratings agencies failed to warn sooner of the risks inherent in those securities, and bolstering international cooperation to supervise world markets.

The U.S. response has been more measured, with McCormick cautioning against a "rush to judgment" on regulatory and policy matters.

But if U.S. economic data continues to weaken, dragging down global economic growth, Europe may find it has too much in common with the United States.

(Editing by Richard Satran)