By Balazs Koranyi and Francesco Canepa
FRANKFURT (Reuters) - The European Central Bank is all but certain to unveil new stimulus measures on Thursday, pushing policy closer to its limits to help the euro zone economy cope with the shock of the coronavirus pandemic.
With millions of people in lockdown, markets in freefall and companies struggling with disrupted supply chains, the economy is already reeling, piling pressure on the ECB to roll out much of what it has left in its depleted policy arsenal.
Emergency rate cuts by the U.S. Federal Reserve and the Bank of England also signal an urgent need to soothe uneasy investors as the epidemic and associated market panic could quickly trigger a recession, dealing another blow to the struggling currency bloc.
The ECB is widely expected to provide new, ultra-cheap loans for banks to pass onto small and medium-sized firms, in what is seen as the first major test for ECB chief Christine Lagarde, who took over in November and has billed herself as the "wise owl" of monetary policy.
The bank is also likely to debate an interest rate cut, though such a step is far from certain.
While markets have priced in a 10 basis point move, rates are already at a record low of minus 0.5% and many policymakers have said further cuts could be counterproductive because they hurt bank margins to the point of thwarting lending.
Still, acting counter to market expectations and rate cuts elsewhere would risk fuelling market turbulence, undercutting the very purpose of the bank's stimulus package. It could also push the euro higher, putting downward pressure on inflation, an uncomfortable prospect given anaemic price growth.
The ECB could also discuss stepping up asset purchases to keep corporate borrowing costs in check and relieve pressure on sovereign bond spreads, which have widened sharply as investors flee weaker sovereigns such as Italy, Spain and Portugal.
"None of these monetary measures will stop the spread of the virus. But they are among the best measures to prevent the economic damage being even more severe in potential second-round effects," Berenberg economist Florian Hense said.
The World Health Organization called the coronavirus a pandemic for the first time on Wednesday, saying other countries would soon join Italy and Iran on the frontline of the disease.
President Donald Trump meanwhile imposed restrictions on travel to the United States from 26 European countries for a month.
Markets tumbled, with European stocks (STOXX) more than 5% lower early on Thursday with banks and travel firms (SXTP) performing even worse.
The euro (EUR=) was little changed, however, at $1.1260 after hitting a one-year high this week, and German 10-year yields were (DE10YT=RR) 2 basis points lower.
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In an unusual move, the ECB's bank supervision arm, which is supposed to act separately from monetary policy, is also expected to outline ways it is prepared to help the financial sector cope, sources told Reuters.
But Lagarde, who has encouraged ECB staff to work from home if they wish to, will also stress that it is up to governments to react to the epidemic and that they should use leeway in their budgets, a more powerful weapon than whatever the ECB can offer.
She has already told EU leaders that inaction could lead to calamity on a par with the global financial crisis.
German Chancellor Angela Merkel said she shared Lagarde's concerns, adding: "We will do what we need to get through this."
Many economists expect Germany, Europe's economic powerhouse, to be in recession in the first half of this year and some predict a similar outturn for the entire bloc.
While the ECB is keen to help, it has already used up its most powerful weapons in nearly a decade of stimulus. Interest rates are at record lows, it has gobbled up 2.6 trillion euros ($2.94 trillion) of mostly government debt and has for years offered essentially free cash to banks to keep them lending.
With rates so low, the ECB is already approaching the so-called reversal rate at which further cuts do more harm than good. Low rates are also fuelling housing bubbles which some policymakers argue could sow the seeds of a future crisis.
Compounding the ECB's headache, oil prices have crashed, a double-edged sword for rate-setters.
While lower crude prices boost growth and consumer purchasing power through lower fuel prices, they also drag inflation sharply lower -- a problem as the ECB has undershot its target of almost 2 percent since 2013.
Some economists expect inflation to fall to zero this spring if crude prices stay at current levels, raising fears of a damaging deflation spiral.
The ECB will also release economic forecasts on Thursday as it does every three months, though the cut-off date for their underlying assumptions was before the worst of the market turmoil and the oil price crash.