5 Questions Ahead of the ECB's Policy Meeting

The eurozone's economy is strengthening, but the European Central Bank remains on full alert.

The bank is buying EUR60 billion (about $65.2 billion) of bonds each month, its short-term interest rates are negative, and it has pledged to do even more if the outlook darkens. The ECB's balance sheet, at $4.5 trillion, is set to surpass that of the Federal Reserve next week.

Those aggressive policies look increasingly out of place in a strengthening economy that outpaced the U.S. last year. Financial markets have been volatile in recent weeks as investors weigh the likelihood of a change in direction from Frankfurt.

What is the ECB expected to do this week?

Sit on its hands. While some ECB officials have indicated they would welcome a reduced stimulus, the bank's executive board has cautioned against any premature move. The bank's meeting Thursday is sandwiched between the two rounds of France's presidential elections. Against that uncertain backdrop, ECB President Mario Draghi is expected to play it safe. "The ECB will probably take pains not to make any statements that could move markets," said Franck Dixmier, head of fixed income at Allianz Global Investors.

How strong is the eurozone economy?

It is in good shape. Business confidence is at a six-year high, loan volumes are robust and inflation is far above zero, where it languished for much of last year. The International Monetary Fund last week raised its economic growth forecast for the region to 1.7% this year. Still, problems remain. Unemployment, at 9.5%, is far too high, and debt levels remain elevated, particularly in the public sector. Crucially, core inflation -- excluding volatile energy and food prices -- has remained stubbornly low.

How soon could the ECB start winding down its stimulus?

Some policy makers are eager to start reining back the bank's aggressive policies as inflation approaches its target of just below 2%. But others worry that any misstep in communications could undermine the economic recovery. For now, the ECB is expected to use a recent downturn in inflation, to 1.5% in March, to justify the status quo. Many analysts think the ECB's following meeting, on June 8, might be a good time to signal a policy shift, perhaps by removing pledges to boost its stimulus again if the outlook darkens.

What else could the ECB do?

Policy makers might tweak the language of their policy statement to reflect lower risks to the economic outlook. Given the tense political backdrop, even that small change might not come to pass. Mr. Draghi might also clarify the likely sequence of events when the ECB does exit its stimulus. Financial markets are positioned for a slightly hawkish message, so a repetition of the status quo would be seen in a dovish light, says Holger Sandte, an analyst at Nordea.

What about Germany?

Complaints in Germany about the ECB's policies have grown louder as the economy has picked up. In Washington last week, German finance minister Wolfgang Schäuble blamed his nation's trade surpluses in part on policy makers in Frankfurt, and urged the ECB to follow the Federal Reserve's example by starting to exit easy-money. For its part, the IMF sided with the ECB, arguing that the banks should maintain its current stimulus.

Write to Tom Fairless at tom.fairless@wsj.com

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April 27, 2017 00:14 ET (04:14 GMT)