Mario Draghi faces moment of truth as man with power to steady eurozone

The meeting will be held on the day before the 70th anniversary of the Allied landings in Normandy, but make no mistake: Thursday is D-day for the European Central Bank. That's D as in Draghi, because after all of the ECB governor's silver-tongued manipulation of the market – all the nudges, winks and hints – the financial markets now require Mario Draghi to do more than just talk.

Expectations are high, probably unrealistically so. After the bloody nose received by mainstream parties in last week's elections to the European parliament, former US treasury secretary Larry Summers had some harsh things to say on US news network CNN about the mess that policymakers had made of things: "The European common market, European monetary union, was an elitist project that was driven by elites, that led to consequences that were entirely unpredicted by elites, that have been catastrophic for millions of people."

Draghi can do little to rekindle love for the idea of ever-closer union in Europe – a project damaged, perhaps beyond repair, by recession, unemployment and austerity. Nor is he in a position to eradicate the structural problems of the euro – its one-size-fits-all interest rates, its inbuilt deflationary tendencies – that have been obvious since its creation. These are beyond his remit. The "elite" lambasted by Summers has to decide whether to press ahead with closer fiscal integration – a centralised budget that might make the single currency work better – in the face of clear voter hostility to greater unity.

Instead, the ECB meeting will have a less ambitious, but still crucial, agenda. As Investec economist Philip Shaw puts it, Europe's central bank has four key objectives this week: "To ease policy to meet its inflation target; to prevent inflation expectations from being dislodged to the downside and increasing the risks of deflation; to stem upward pressure on the euro; and to secure and preferably speed up the recovery, possibly by encouraging credit flow."

This is not just a question of preventing the eurozone from becoming the new Japan – where activity is relentlessly weak and both consumers and businesses are deterred from spending by the knowledge that deflation will lead to prices being lower in the future than they are today. The ECB also has to take into account that some parts of the eurozone have suffered from Great Depression-style falls in output since 2008 and that many economies are operating way below pre-recession levels.

What's more, the big discrepancies in economic performance across the eurozone – especially between Germany and France – will put increasing strains on the central bank.

Estimates by the Centre for Economic and Business Research suggest Greek economic output will be more than 23% lower at the end of 2014 than it was in 2008. Italy, Spain and Portugal will have seen declines of 7%, 6% and 6% respectively while even Ireland, the poster child for austerity, will still be operating 4% below its pre-recession level.

The eurozone emerged from double-dip recession a year ago, but its recovery has been modest. Exports have been hampered by the slowdown in the global economy and by the strength of the euro. Investment has been constrained by the unwillingness or inability of banks to lend. Unemployment, which averages 12% across the eurozone, has discouraged consumer spending.

Latest data suggests that consumer and business confidence is picking up, but even so, growth this year currently looks like coming in at around 1% – not fast enough to prevent disinflationary pressure from growing. The cost of living across the 18-nation single-currency area rose at an annual rate of 0.7% in April, well below the ECB's target of "below but close to 2%". The bank will publish its own forecasts for inflation on Tuesday, but markets anticipate that it will pencil in a figure of only around 1.3% for 2016. That leaves Draghi with plenty of scope for action and he said at last month's ECB meeting that he and his fellow policymakers would feel "comfortable" with acting next time.

All that is at issue is what form of the attempted policy stimulus will take. There are three possibilities:

■ Cut interest rates First on the list will be lowering rates. Borrowing costs in the eurozone are already close to zero but Draghi will go further. The ECB's refinancing rate – the rate at which commercial banks can borrow from Frankfurt – is currently 0.25% and a cut to 0.15% is widely predicted.

Of rather greater interest will be what Draghi does to the deposit rate – the interest banks get when they lodge money with the ECB. The strong speculation is that at this week's meeting it will become the first major central bank in the world to announce a negative rate, probably -0.1%. What that means is that will cost banks money to deposit money at the ECB. The hope is that they will lend the money out instead.

■ Boost lending The second item on the agenda will be whether more targeted steps need to be taken to boost lending, especially in some of the weaker countries on the eurozone's periphery. Draghi has noted that it is much harder for good businesses to get access to credit in Spain than it is in Germany, with figures showing that 25% of viable Spanish small and medium-sized enterprises are constrained by a lack of finance, compared with just 1% in Germany.

Here, the ECB is likely to come up with its own version of the Bank of England's Funding for Lending scheme, which gave banks access to cheaper credit but only on condition that it was lent rather than hoarded. In the past, the ECB has used long-term refinancing operations (LTROs) to provide help to eurozone banks: a more targeted LTRO looks likely this week.

■ Start printing money The really big question is whether the ECB is prepared to go the whole hog and announce its own quantitative easing programme, something already tried by the US Federal Reserve, the Bank of England and the Bank of Japan.

Most analysts believe the threat of deflation would need to get more serious before the ECB took this step, although Jennifer McKeown at Capital Economics thinks that, to end an economic and financial struggle that is now longer-lasting than the second world war, QE will ultimately be required.

"We still think a bolder programme of asset purchases will be necessary to get the recovery going and avoid prolonged deflation," she says.

Country by country: how invididual economies are faring

Germany Europe's biggest economy began 2014 strongly, fuelling hopes it could drag the eurozone with it. Growth hit a three-year high – but the recovery appears to be slowing. Business confidence dipped last month after exports fell by the largest amount in 11 months.

France The new "sick man of Europe" is exhibiting some alarming symptoms as it falls further behind its neighbours. The economy stagnated in the first quarter of 2014, and unemployment hit another record high in April. No surprise that only 3% of the population wants President Hollande to run again in 2017.

Italy Almost 10% was wiped off the size of Italy's economy after a 27-month recession that only ended last autumn. Charismatic prime minister Matteo Renzi now promises reforms to make Italy more competitive. But, worryingly, the economy went into reverse again between January and March.

Spain The Spanish economy is finally heading in the right direction, after its banking sector was propped up by a €41bn bailout programme. But its jobless rate remains a stain on the eurozone recovery, with more than one in four adults still out of work.

Portugal Lisbon emerged from its bailout programme last month, but faces many more years of cutbacks if Portugal is to hit its deficit targets. The national debt is now a concerning 129% of national output; no wonder economists were alarmed that GDP shrank by 0.7% in the last quarter.

Greece The six-year depression is expected to end this year, and Greece made a remarkably successful return to the bond markets in April. But political uncertainty is mounting: with the coalition's majority down to just two, could Athens be forced into an early election?

Ireland After three traumatic years, Ireland successfully left its bailout programme last December. But years of cuts lie ahead – former Taoiseach John Bruton predicts another 10 years of austerity budgets unless growth accelerates. Workers are suffering a wage squeeze, with average earnings falling in May.

Cyprus The island is struggling to return to normal after the trauma of last year's bailout, which sent it into a deep recession. There are still strict restrictions on transferring money overseas, and Cypriot ministers have warned the economy would suffer badly if tougher sanctions were imposed on Russia over the Ukraine crisis.

Slovenia Tough austerity and privatisations have helped maintain investors' confidence and shored up its banking sector. But they cost prime minister Alenka Bratusek the leadership of her party. A snap general election is coming in July, raising fears that Slovenia's reform programme could stumble.

Austria Austria epitomises the classic northern core of the eurozone, with the lowest jobless rate of any member of the single currency. But its economy may be hitting a sticky patch – manufacturers report that new orders are stagnating.

Finland Conditions have deteriorated since 2012 – the country has tumbled into recession and economists fear it may not pull out until 2015. With household debt rising and firms regularly issuing profit warnings, Finland is no longer a model to the rest of Europe.

Netherlands A housing market crash has left many households deep in negative equity. That's hitting consumer spending, with retail sales slumping by 2.2% in March. Like Finland, the Dutch economy has deteriorated just as the southern periphery has improved.

Graeme Wearden