The consensus forecast of economists suggests the central bank will cut the main refinancing rate by 50 bps to 2.00%, a view which is also shared by implied market forecasts suggesting a 65% chance of a 50bp reduction, according to the Euro Overnight Index Average (EONIA), or a 7% chance of a 75bp rate reduction, according to Overnight Index Swaps.

"We think [the ECB is] going to cut 50 which is in line with the market expectations," said RBC Capital Market fixed income strategist Richard McGuire. "What we're looking for from the statement is any acknowledgment that inflation risks have shifted to the downside. In the last statement they pared back the lingering upside inflation risks and said they were more balanced than in the past."

While he declined to speculate as to how large any moves in fixed income will be on such comments, McGuire argued that an acknowledgment of downside inflation risks would be bullish for the front end of the curve, (Euribor contracts), and have a steepening effect on the 10- to two-year spread on European bonds.

On trader in London suggested that, "this week it's going to be more the rate cut than rhetoric that will matter with the market split between a 25 and a 50 bps cut," and that the outside chance of 75bp cut priced in by the OIS swap market is not realistic.

"(ECB President Jean-Claude) Trichet was clear last month that markets cannot expect further large cuts from the European Central Bank," he said. He believes that fixed income markets have roughly 43 bps worth of cuts priced in suggesting that there would be more reaction on a 25bp rate reduction than a 50bp cut.

Consequently, he expects the March 2009 Euribor contract to sell roughly 30 ticks if the central bank holds rates, an eight-tick decline on a 25 bps cut and a marginal move, up one tick or so on a 50bp rate cut from the bank.

Another strategist suggested that the biggest moves will be in the shorter end of the curve, but that the move lower in bond prices won't be sustained.

Any sell-off in the short end of the curve could be seen as a buying opportunity, he said. "Two-year yields back up 10 basis points pretty quick but I want to stress that won't last," he said. "People would start to think that the ECB would have to make more cuts at a later stage as the economy continues to weaken."

On the foreign exchange side, strategists are convinced the currency can only move lower.

Ian Stannard, currency strategist from BNP Paribas, said anything less than a 50bp rate cut could cause a sell-off in the euro against the U.S. dollar as economic concerns win out over inflation fears. Such a reduction might slow the sell-off in the euro but won't reverse it.

"Any support we get if we do see a more hawkish ECB is going to be short-lived in light of the current data flow," he said. "The euro will get punished for the ECB dragging its feet. Unfortunately I see very few scenarios where we are going to see a medium-term positive response for the euro."

Meanwhile, Derek Halpenny, European head of currency research at the Bank of Tokyo-Mitsubishi, said hawkish comments from Trichet won't provide much support for the euro, and that he expects the euro to continue to sell off and hit support at 1.30 USD ahead of the meeting.

"That is only going to a temporary degree of support. Ultimately I think the euro is going to trend lower and the U.S. dollar is going to remain the best currency to stay in," he said. "I think the euro will be sold into any kind of rally."

By Erik Kevin Franco, This email address is being protected from spam bots, you need Javascript enabled to view it with contributions from Neils Christensen, This email address is being protected from spam bots, you need Javascript enabled to view it , edited by Nancy Girgis, This email address is being protected from spam bots, you need Javascript enabled to view it

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