The United States and euro zone are dangerously close to recession, Morgan Stanley said on Thursday, criticizing policymakers and predicting the European Central Bank will have to reverse its rates policy.

The Morgan Stanley research note, which cut global growth forecasts, was cited by stocks traders as adding to market nervousness over the U.S. and euro zone debt crises and the economic drag of austerity measures in debt-burdened countries.

Deutsche Bank added to the gloomy market tone by cutting its gross domestic product forecast for China, a major growth engine for the world economy.

Morgan Stanley cut its global GDP forecast to 3.9 percent growth from 4.2 percent for 2011, and to 3.8 percent from 4.5 percent for 2012.

It also predicted the European Central Bank's next interest rate move would be a cut, a sharp contrast to Reuters last ECB poll earlier this month when just one bank of around 50 surveyed -- Australia's Westpac -- forecast a cut next. The ECB has raised its benchmark rate twice this year.

Our revised forecasts show the U.S. and the euro area hovering dangerously close to a recession -- defined as two consecutive quarters of contraction -- over the next 6-12 months, Joachim Fels, who co-heads Morgan Stanley's global economics team, said in a research note dated Wednesday.

That was not the bank's base case scenario, he said, noting the corporate sector still looked healthy and lower inflation will ease pressure on consumers' wallets, while central banks such as the Federal Reserve and ECB could try to loosen policy further.

A negative feedback loop between weak growth and soggy asset markets now appears to be in the making in Europe and the US, Fels said.

Against this dire growth backdrop, we no longer expect the ECB to hike rates. Instead, we now see the Bank cutting rates next year. We lower our refi rate forecast for the end of 2012 to 1 percent from 2 percent before.

Economists are beginning to latch on to a shift of view already evident among investors. Traders in financial markets have been moving to price in a cut since the ECB's last press conference on August 4. Standard Bank said this week it expects the ECB to make its first cut early next year.

POLICY ERRORS

Weak growth data from the euro's main economies, Germany and France, has put further pressure on European politicians who have been haggling over ways to stop the bloc's sovereign debt crisis from engulfing Spain and Italy.

The U.S. economy also stumbled badly in the first half and came dangerously close to contracting in the first quarter. High unemployment, a bruising political battle in Washington over the debt ceiling and spending cuts in July and a stock market slump all helped push U.S. consumer sentiment to its lowest level in more than 30 years.

Recent policy errors - especially Europe's slow and insufficient response to the sovereign crisis and the drama around lifting he U.S. debt ceiling -- have weighed down on financial markets and eroded business and consumer confidence, the Morgan Stanley note said.

It now sees growth in developed market economies averaging only 1.5 percent this year and next, down from his previous view of 1.9 percent and 2.4 percent, respectively.

Growth in emerging market economies will slow to 6.4 percent this year from 7.8 percent in 2010, Fels estimated.

This means that emerging market economies -- which now account for half of global GDP -- will generate 80 percent of the global GDP growth that Morgan Stanley is forecasting for 2011 and 2012, Fels said.

Most economists say they are not cutting their growth forecasts for emerging Asia for now, as the continent is less dependent on exports to Western markets than it was when the financial crisis hit in 2008.

Morgan Stanley left its 2011 growth forecast for China unchanged at 9.0 percent, versus 10.3 percent last year, but dialed back growth expectations slightly for Russia and Brazil.

If the West does slump back into recession, or a prolonged period of meager growth, analysts say China may not be in a position to reprise its role in supporting the global economy as it did in 2008, when it announced a massive stimulus program.

Inflation unexpectedly quickened in China in July, putting pressure on the central bank to keep prices in check with more interest rate rises even as growth showed signs of cooling.

(This story is corrected to show forecasts in paragraph 4 are for global not U.S. growth.)

(Reporting by Tenzin Pema in Bangalore and Marc Jones in London; Editing by Mathew Veedon/Kim Coghill/Ruth Pitchford)

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