(Reuters) -- The European Central Bank is expected to hold back from policy moves when it meets on Wednesday, instead urging governments to address the euro zone's crisis, but it could indicate a readiness to cut interest rates as early as next month given a weakening economy and Spain's banking troubles.
The ECB is widely seen as the only institution capable of immediate action on behalf of the currency bloc, raising pressure on the bank to announce new measures after its meeting - which will be held a day earlier than usual due to a holiday.
The bank's dilemma is that if does too much, pressure for government action falls. Yet if it does nothing, troubled sovereign debtors could find it harder and harder to finance themselves or maintain confidence in the banks that have bought much of their debt. Consequently, the ECB is likely to keep its weapons holstered until after the EU summit at the end of June.
Even then, the measures it is most likely to take are ones which it views as being most directly in its purview and that help the economy and ease pressure on banks, without letting governments off the hook: an interest rate cut and an additional ultra-long term loan, similar to the two 3-year offers it has already made. And these are likely to be dependent on summit decisions.
They are likely to signal the possibility of rate cuts and additional (long-term refinancing loans for banks) if progress is made on the political front, Citigroup strategist Steven Englander said in a note.
Investors are likely to view it as the ECB using the policies they are comfortable with, rather than the ones that will be effective.
Forward-looking indicators have been dismal over the past month and business surveys showed on Tuesday that all the euro zone's major economies are in decline - even Germany is no longer immune.
But the ECB traditionally seeks to prepare markets for such policy moves, and President Mario Draghi told the May news conference the Governing Council had not talked about cutting rates.
We did not discuss any specific move on interest rates but we certainly discussed our general monetary policy stance, which we found accommodative, Draghi said last month.
In a Reuters poll, 11 out of 73 economists expect the ECB to cut rates on Wednesday and 27 - up from 14 just two weeks ago - see a decrease by the end of the year.
While ECB policymakers have recently stressed that they are close to their policy limit, they also want to avoid appearing disengaged, and could signal they are ready to cut rates from the already record-low level of 1.0 percent next month.
We doubt that the ECB will cut interest rates as soon as Wednesday - although it is not inconceivable given the euro zone's heightened economic and sovereign debt problems, IHS Global Insight economist Howard Archer said in a note.
But we do now think it is highly likely that the ECB will cut interest rates to 0.75 percent in the third quarter.
Adding to calls for ECB action, International Monetary Fund Managing Director Christine Lagarde said the ECB has room to cut interest rates.
If the ECB signaled a rate cut, it could also indicate a drop in its deposit rate to zero from the current 0.25 percent, to discourage banks from parking the cheap funds they have borrowed from the ECB back at the central bank.
But some analysts question the efficacy of rate cuts.
It is hard to think that the euro's problems result from too high a refi rate, Citigroup's Englander said.
PAIN IN SPAIN
Spain said on Tuesday that it was getting priced out of credit markets. Finance chiefs of the Group of Seven major economies held emergency talks as the debt crisis honed in on the bloc's fourth largest economy, whose autonomous regions have overspent and whose banks and homeowners are laden with bad debts from a burst property bubble.
Despite Spanish pleas for the ECB to restart its bond-buying program, Draghi is likely to stick unflinching to his line that the program is still ongoing - even though the central bank has not bought any bonds in the past three months.
However, one measure it could take on a short notice is to further loosen the rules against which it lends funds to banks. This would open up reliable funding to banks that are being shunned by other lenders in the money market - but even here, the ECB wants to wait until after the summit.
The ECB is universally expected to extend its unlimited provision of loans in liquidity operations. So far, the promise runs until July, and the ECB will offer to give banks all the money they request until the end of the year or even longer.
The ECB will also publish its next set of staff economic forecasts, which analysts expect to show somewhat lower growth for this year and next but to leave inflation estimates largely unchanged.
In March, the ECB forecast the economy would shrink 0.1 percent this year, bouncing back to 1.1 growth in 2013. Prices were seen rising 2.4 percent in 2012 and 1.6 percent next year.
Especially interesting will be the estimate for next year's inflation. Even a minor downward revision would put it well below the ECB's goal of just below 2 percent and drum up calls for deeper cuts in interest rates.
(Reporting by Sakari Suoninen; Editing by Ruth Pitchford)