European Central Bank President Jean-Claude Trichet is expected to prepare the ground for a pre-Christmas interest rate cut at his final policy meeting on Thursday and offer banks further protection against the euro zone's worsening debt storm.
The ECB is widely expected to keep rates unchanged at 1.5 percent when it meets in Berlin, but calls for a cut have grown louder in recent weeks amid signs the euro zone economy is deteriorating further and as Greek default fears weigh heavily on confidence in the bloc's banks.
In a Reuters poll late last week, 56 of the 76 economists questioned saw rates being left unchanged, while 20 expected a decrease.
Since then things have soured further. On Tuesday, French-Belgian municipal lender Dexia SA became the first European bank to bailed out due to debt crisis problems.
I think it is really finely balanced, said Nomura economist Jens Sondergaard. The reason why we're not moving to a formal rate cut is that they (ECB) have a tendency to prepare the ground first.
It seems a very sudden U-turn to go from upside risks to inflation to balanced risks to inflation and then to a rate cut. Has the world really changed that significantly in the last two months?
At its September meeting, the ECB changed course and put its rate hikes -- started in April as the first of the major central banks -- on hold, saying euro zone inflation risks were no longer skewed to the upside, but were now broadly balanced.
Since then, signs that the economy is stalling have grown. Goldman Sachs now expects the euro area to slide into a mild recession in the fourth quarter, as do others.
Oxford Economic Forecasting economist Tom Rogers said the ECB should cut interest rates below 1 percent should the Eurozone head back into recession, adding that it was the best equipped to try to buffer the impact of a slowdown.
In a full-page newspaper advert, French asset manager Carmignac Gestion, which has about 55 billion euros under management, asked Trichet to go further and cut rates to zero and buy unlimited amounts of countries' distressed debt.
Farewell, you certainly won't be missed! read the ad, which looked like a letter to Trichet. This will be your last chance to leave on a positive note.
While some like Carmignac have criticized the ECB for not doing enough to fight the sovereign debt crisis, others like the Bundesbank have said the ECB has already gone beyond its limits and is putting its independence at risk.
Recent proposals to resolve the crisis have included the idea of turning the European Financial Stability Facility (EFSF) into a bank that can tap the ECB for funds.
While Trichet himself on Tuesday said he opposed such measures, markets will want to know the consensus ECB view as change may be afoot with Mario Draghi set to take over as president in November.
LIQUIDITY IS KING
The ECB will also probably opt to pump more liquidity into the market before cutting rates, economists said.
Policymakers have given clear hints they are prepared to bring back the ECB's 12-month tender last used at the end of 2009, and there have been suggestions it plans to resurrect its program for buying covered bonds.
The deepening crisis has already forced the ECB back into emergency mode. It has reintroduced six-month euro funding, a measure it had previously mothballed, and extended limit-free funding in all its operations until at least mid-January.
The re-introduction of a 1-year LTRO (lending operation) seems to be the natural next step, and we would not be surprised if Trichet were to hint at even longer LTROs if this were deemed necessary, said Goldman Sachs economist Dirk Schumacher.
The ECB first bought covered bonds between 2009 and 2010 in a year-long, 60 billion euro program. Goldman Sachs said they could even envisage such a program being expanded beyond secured bank debt if another one was introduced.
Goldman also said euro zone consumer price inflation at 3.0 percent -- the highest level in almost three years -- made an immediate rate cut a more difficult sell for the ECB.
The bank raised interest rates for the second time this year only in July. While a rapid U-turn may be painful for the ECB's reputation, economists believe Trichet may well flag such a step to smooth the way for his successor Draghi, who takes over the presidency from November.
If they don't cut though on Thursday, I think they will have cut rates by November at the latest, said Royal Bank of Scotland economist Nick Matthews.
If they do cut, I don't think there is going to be a unanimous decision. I think there are some on the Governing Council who would prefer to focus only on the non-standard measures for now.
The rate announcement is due at 1145 GMT and Trichet will speak at 1230 GMT.
(Editing by Hugh Lawson)