Japan slump deepens

By Wanfeng Zhou

NEW YORK (Reuters) - The U.S. financial system is healing, Treasury Secretary Timothy Geithner said on Wednesday, but contractions in Japan's and Mexico's economies showed the path to a global recovery could be long and tough.

The U.S. Federal Reserve said it saw modest improvements in the U.S. economy last month, but cut its forecast for economic growth over the next three years.

World Bank President Robert Zoellick was equally cautious, telling a meeting of regional central bankers in Finland that the global situation was still getting worse but "we are likely to see the rate of decline lessen."

Geithner said the U.S. financial system was "starting to heal" after a time of severe trauma, thanks to the government's bailout efforts, and that a program for cleansing toxic assets from banks will start over the next six weeks.

"We still face a very challenging economic and financial environment, and we need to be careful to preserve substantial resources and flexibility to deal with future contingencies," Geithner told the Senate Banking Committee.

Despite some modest improvements, the Fed gave a more pessimistic view of the world's largest economy, projecting a contraction of 1.3 to 2.0 percent this year and a rise in the unemployment rate to between 9.2 and 9.6 percent.

U.S. Treasury debt prices rose after minutes from the latest Fed policy meeting in late April showed officials discussed buying more securities, including government debt, to help spur the economy.

"Fed officials judged the financial system to be vulnerable to further shocks," said John Canavan, analyst at Stone and McCarthy Research Associates in Princeton, New Jersey.