Economic policymakers around the world are running out of tools to boost the flagging global economy, the World Bank said in a report Wednesday.

The bank said the US Federal Reserve, the world's most influential central bank, has little room left to cut interest rates and expects the Fed to leave them on hold this year if growth picks up slightly as expected.

"A worrisome characteristic of the current economic environment is that macroeconomic policies may be running up against their limits," said the bank's 2003 Global Development Finance report.

In fact, policies this year and next are more likely to be less stimulative or "restrictive" than expansive, the bank concludes.

The report comes a day after the Institute of International Finance, a leading financial lobbying group, said the global economy is facing serious problems that will require a coordinated effort from rich nations to bolster prospects. The Iraq war is a major risk to the outlook and could knock off $75 billion to $100 billion from global economic growth in the first half of the year, the bank said.

But without the war, the world economy is still in a soft spot.

"We've been constantly cutting our growth forecasts over the last year," Philip Suttle, lead author of the report, said at a press briefing.

"Particularly important, is that regardless of the war, general confidence just keeps slipping."

The bank has not made any estimates for the impact of the outbreak of the deadly Severe Acute Respiratory Syndrome (SARS) on economy. East Asia, the fastest growing region of the world, has so far been the hardest hit by the disease. Suttle said SARS is "an unambiguous negative to growth."

The bank is predicting a hesitant economic recovery in high income countries, with the US economy expanding 2.5 per cent this year and rising 3.5 per cent in 2004. But these forecasts are subject to downside risks

such as a lengthy war.

The euro-zone economy is seen expanding 1.4 per cent this year, rising to 2.6 per cent in the next, helped by expected rate cuts in the first half of this year.

"The European Central Bank has more room to ease and is likely to follow market expectations and possibly trim rates slightly further in the first half of this year," the bank said. However, the report said fiscal spending in the euro area is being constrained by the Growth and Stability Pact.

Japan is expected to grow just 0.6 per cent this year, and 1.6 per cent in 2004. The Bank of Japan should maintain a "truly stimulative" monetary policy, the report said, warning the country's government debt has reached a "dangerous level".

Regarding currency exchange rates, the bank said a weaker dollar, particularly against the euro, the yen and the Chinese yuan, would help restore balances in the global economy but added it would be difficult to engineer such a change.

The global trend toward deflation poses new challenges for policy makers, the report said, and urged monetary authorities to focus on avoiding the "lower boundaries rather than the upper limits of the forward-looking inflation targets when setting policy." However, the bank said that with central banks mindful of the risks, the chances of avoiding generalized global deflation look good.

Growth in developing countries is expected to be 4.0 per cent this year, increasing to 4.7 per cent next year.

East Asia and the Pacific region will lead the way with growth surging 6.4 per cent, although it would be slightly lower than 6.7 per cent last year.

So far, there has been little impact on the war with Iraq for the developing world.

"For many developing countries, the financial strains of the war to date have been surprisingly muted," Suttle said.

However, that could change if investors become more risk averse and those sending money home suffer from war's impact on rich countries.