Mario Draghi is under pressure to deliver a convincing response to the global economic downturn this week.

The European Central Bank chief and the rest of his governing council will meet in Frankfurt on Thursday to decide how to counter the threats posed to the eurozone by the slowdown in growth emerging markets and the sharp fall in the oil price.

A new stimulus package is seen as a near certainty after prices dropped in the year to February. New staff projections from the ECB’s economists are expected to downgrade economic forecasts, showing the eurozone will be saddled with weaker inflation for longer.

Mr Draghi’s own reputation as a man able to do whatever it takes to steer the eurozone towards recovery is at stake. In December, the ECB president was unable to deliver a package in line with investors’ expectations.

There are several options available to the governing council. None, however, are free of drawbacks.

Rate cuts

The ECB now charges 0.3 per cent on eurozone banks’ deposits parked in accounts at Eurosystem central banks. Markets expect the ECB to cut what is known as the deposit rate by 10 basis points on Thursday, with some ECB watchers expecting a deeper cut to minus 0.5 per cent.

There was disappointment in December when the central bank lowered the rate by just 10 basis points, and not the 20 basis point cut that some had hoped for.

But the mood on negative rates has changed.

The sell-off in European bank equities since the start of the year was driven partly by investors’ concerns that the policy is eroding banks’ profitability.

Mr Draghi and another member of the ECB’s top-ranking executive board, Benoît Cœuré, have said central bankers are not responsible for the profitability of lenders — although Mr Cœuré said last week that the ECB was “well aware” that lenders had taken the brunt of the costs of negative rates and had not passed the levy on to retail depositors.

Vítor Constâncio, the ECB’s vice-president and the man responsible for the central bank’s financial stability department, has said they could cut rates in a way that mitigates the “immediate, direct impact” on lenders.

Tiered rates

The ECB could follow the Bank of Japan’s lead and introduce a tiered deposit rate system to shield banks from most of the impact of negative rates. That would, however, expose the central bank to criticism it is engaging in short-sighted moves to weaken its exchange rate.

The BoJ introduced a tiered system earlier this year, charging its negative deposit rate of minus 0.1 per cent only on a fraction of banks’ reserves stored in its coffers.

The ECB could, like the BoJ, impose a lower deposit rate on only some deposits. But while that protects the banks, it would blunt one of the most important channels through which negative rates are supposed to work.

The ECB views its shift below zero interest rates as a complement to its quantitative easing programme. Both policies, it says, force banks and investors to buy riskier assets to compensate for the costs of negative rates.

But a tiered system would weaken this so-called “portfolio rebalancing effect”. It would also remove the pressure on banks to pass on the costs of negative rates to businesses and households, making it less likely they would spend more.

There are serious doubts that negative rates can weaken currencies as much as officials hope — the BoJ’s surprise move only managed to halt the yen’s appreciation for a few days.

Expand QE

The ECB intends to buy € 60bn-worth of mostly government bonds each month from now until March 2017 under its landmark quantitative easing programme. Many analysts expect the governing council to take that figure from € 60bn to € 70bn on Thursday.

The latest economic projections from ECB staff, which governing council members see at the meeting, will be the first to forecast what will happen to inflation in 2018. If inflation is expected to remain below target until then, then the asset purchase programme could be extended for at least another six months.

The ECB could also buy other assets such as corporate bonds or bank bonds.

An expansion in the QE programme has already met with resistance from the governing council's hawkish wing, which is much keener on rate cuts than bond purchases. However, the fiercest of the hawks, Bundesbank president Jens Weidmann, is one of four of the governing council's 25 members without a vote this month under the ECB's rotating voting system, potentially giving Mr Draghi a freer hand to satisfy investors.

Copyright The Financial Times 2016