Morgan Stanley today said the United States and Europe are dangerously close to recession, blaming in part policy errors by authorities on both sides of the Atlantic.

The investment bank said a slow European response to the euro zone's mounting sovereign debt problems and the US political battle over raising its debt ceiling had hit financial markets and eroded both business and consumer confidence.

"Our revised forecasts show the US and the euro area hovering dangerously close to a recession - defined as two consecutive quarters of contraction - over the next 6-12 months," it said in a new report.

For the moment, the combination of cash-rich companies, oil prices falling from their highs earlier this year, and rate-cutting by central banks appear more likely to prevent a plunge into a 'double-dip' recession, after the 2008-2009 collapse of growth, the bank said.

But it added that policymakers have been making things worse by tightening spending to pare fiscal deficits.

"A negative feedback loop between weak growth and soggy asset markets now appears to be in the making in Europe and the US.
This should be aggravated by the prospect of fiscal tightening in the US and Europe," it said.

Morgan Stanley cut its global economic growth forecast to 3.9 per cent in 2011 from the previous 4.2 per cent, and to 3.8 per cent from 4.2 per cent in 2012, mainly due to the stagnation in advanced economies.

It said the G-10 developed economies - the United States, the euro zone, Britain and Japan - will only grow at about 1.5 per cent this year and in 2012, more than a full percentage point lower than in 2010, when the countries were rebounding from the 'Great Recession'.

But it noted a clear divergence between the developed countries and the giant 'BRIC' emerging economies - China, India, Russia and Brazil - which will expand 6.4 per cent - slightly lower than its previous forecast of 6.6 per cent - and 6.1 per cent in 2012.

It pointed to errors by the leadership in Europe and in Washington, and actions by the European Central Bank, for enhancing already-weak economic growth.

"The ECB's past rate hikes and, more so, the sovereign crisis and the additional fiscal policy tightening as well as the banking sector funding stress it produces, will take an additional toll on growth, in our view," Morgan Stanley said.

It also cited the months-long battle between US Democrats and Republicans over passing an increase to the US debt ceiling, which raised fears that the country might default on its debts because of a political deadlock.

And it pointed to efforts in the United States and Europe to cut government spending which could slow growth. The bank said the six months from October to March would be critical for the US economy, "when we may see some fallout from the heightened volatility of risk markets... and when we get an automatic tightening of fiscal policy if, as our US team currently assumes, this year's fiscal stimulus measures will expire."

The report, together with new data pointing to a stall in the United States, sent stock markets plunging, with the leading European and US markets losing more than four per cent Thursday.