World Entering 'Dangerous New Phase': Lagarde

Christine Lagarde, the managing director of the International Monetary Fund, warned that the global economy is entering a "dangerous new phase" on Friday, ahead of the G7 summit in Marseilles, France.

Yoshikazu Tsuno | AFP | Getty Images

French finance minister Christine Lagarde is seen as a front-runner to succeed Strauss-Kahn.

She warned that both advanced and emerging economies faced key economic challenges, and that governments must "act now" to stop further contagion.

"Policymakers should stand ready, as needed, to take more action to support the recovery, including through unconventional measures," Lagarde said.

"The world is collectively suffering from a crisis of confidence, in the face of a deteriorating economic outlook and rising concerns about the health of sovereigns and banks."

Her speech at Chatham House in London came after a turbulent week for the markets, with the focus on sovereign debt issues in the euro zone and job creation in the US.

She welcomed President Obama's new $450 billion jobs package, announced Thursday, but added "it remains critical for the United States to clarify its medium term plan."

The British government, including Chancellor of the Exchequer George Osborne, who also spoke, was warned that "risk levels are rising" in the UK and the government needs to have a "heightened readiness to respond."

However, Lagarde conceded that the government's response "remains appropriate."

When Lagarde called for the recapitalization of European banks at the Jackson Hole summit in the United States in August, a flight away from European banks resulted in the markets.

Osborne agreed that the situation is "more complex" than in 2008 but described his government's plan as a "rock of stability".

"The underlying cause is the same – excessive levels of debt," he said.

He backed Tim Geithner, the US Treasury Secretary, who wrote in the Financial Times on Friday that the three most important elements for boosting growth are: strengthening growth in the US, stronger actions in Europe to halt the debt crisis and emerging markets like China allowing their currencies to adjust to market forces.

One of the factors weighing down markets is the perception that the situation is worse than 2008, and that there are fewer policy options available to governments and central banks.

Osborne warned that "nothing would be more damaging" to the British economy than an increase in interest rates.

The Bank of England Thursday held its interest rate unchanged at 0.5 percent, a historic low, which has now been in place for two and a half years.

He also supported greater fiscal and institutional integration in the euro zone.

This stance is fast becoming popular, although there has not been any clear signal as to what greater integration would involve.

Stephen King, chief economist at HSBC, told CNBC.com after the speech on Friday that he believed a "fiscal club" would work for the euro zone.

"Countries that don't stick to the guidelines would have their memberships suspended, and if a country chooses not to sign up, it won't get the benefits other countries do and will be pushed to the edge of the euro zone," he said.

"It will not be a proper member of the euro zone."

"As time goes by, there's a danger of getting worse rather than better."

Friday's G7 meeting will include discussions on the risks facing the economy at the moment.

The changing landscape in the Middle East and North Africa following the Arab Spring, and how more advanced economies can help the countries which are transforming their governments, will also be on the agenda.