According to the EONIA curve an implied market forecast suggest an 8% chance of a 25bp hike on Thursday and a 46% chance of a 25bp cut by March.

"After two dovish surprises from Trichet in last two months we are rather cautious, as chances of another dovish statement are very slim," said Christoph Rieger, fixed income strategist at Dresdner Kleintwort. "A lot of the damage has been done recently by ECB hawks in what looked like concerted intervention to pull valuations lower on short end."

Consequently, the risk of another further substantial sell-off in German bonds is limited, but some short covering could be observed if Trichet came off as dovish.

On the other hand, the ECB can talk as tough as they like, but it is becoming clearer and clearer the euro zone is heading for severe lowdown, if not already in recession, with inflation coming down, Rieger added.

"Any sell-off confided very much to the front end," he added. "Two years could even rally."

In the unlikely chance that Trichet sounds the dovish bell at the meeting, one could see the Schatz retest the 103.50 level, and the March Euribor could push around the 95.40 area, but this is unlikely, Rieger reiterated.

Rieger recommends being slightly long ahead of the meeting, but suggests selling some out-of-the-money options as a good strategy given the volatility surrounding the event.

"A hawkish Trichet is the more likely scenario and it would look very strange otherwise if anything different happens because of comments from governing council members last week," agrees Michael Markovic, head of global rates research at Credit Suisse.

Nevertheless, with growth and inflation expected to weaken in the euro zone, bond markets will probably price more aggressive rate cuts over the next twelve months.

In the unlikely event that Trichet comes off dovish, the March Euribor contract would shed 25 bps, but if he is hawkish as expected, there should be no material move.

Chris Turner, head of foreign exchange strategy at ING, said, "The ECB's should downgrade its growth and upgrade the inflation forecast on Thursday, but Trichet will continue to talk tough to ride out upcoming wage round negotiations. That could lift the euro a bit," he added, citing the 1.46 USD mark as the ceiling.

When asked how the market would react if Trichet came off as dovish, Turner replied, "Long positions have been mostly unwound, but 1.43 has solid support."

The Euro-dollar cross is stretched down and has overshot on the downside, he added, so there may be an opportunity to buy the euro near 1.43 USD. In general, euro-sterling should continue to move higher, he added, so if you're long you should stay there.

UBS foreign exchange strategist Geoffrey Yu believes a dovish surprise is not that unrealistic. "Markets are reluctant to short euro head of an ECB meeting given that the Governing Council is naturally hawkish. But last month the euro sold off because Trichet focused more on growth. If he says anything about inflation peaking or inflation expectations speaking, the euro would decline."

Although the scenario is not the base-case outlook for Yu or the markets, he added that one could see the euro falling to the 1.436 USD levels should this occur. On the other hand, if the ECB delivers a hawkish statement, one could see the currency temporarily settling around the 1.45 USD level, but on the long term, the euro should weaken further against the greenback.

Against the pound, it's a "race to the bottom," said Yu, who believes the sterling is oversold against the euro zone currency.

"The UK economy should actually outperform the euro economy when you look at growth measures," he added.

By Erik Kevin Franco, 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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