By Sakari Suoninen

FRANKFURT (Reuters) - The European Central Bank is expected to keep its main interest rate at a record low 0.5 percent on Thursday but tweaks to its economic forecasts may give investors a steer on the future direction of policy.

The euro zone's central bank cut its main rate last month and signaled it was ready to do more should a recovery not materialize in the second half of the year as it expects.

With economic data improving in May, the ECB will probably want to save its last remaining policy firepower for a later date, while stressing it is not out of ammunition.

This may include action to boost lending to smaller firms in the euro zone periphery, although plans to do so are unlikely to have been finalized.

"We won't see any changes on the policy rates," ABN Amro economist Nick Kounis said. "If data were to disappoint going forward, then a refi rate cut becomes an option."

The ECB will release its latest set of staff projections after Thursday's Governing Council meeting, which began at 0700 GMT (3 a.m. EDT).

Analysts expect a slight downgrade to growth forecasts, while the inflation outlook is expected to be little changed from the previous forecasts, released in March.

ECB President Mario Draghi said on Monday he continued to see "a very gradual recovery" starting later this year.

In a Reuters poll, 78 of 81 economists expected rates to remain on hold this month. A firm majority of respondents do not expect the central bank to cut its main refinancing rate or its deposit rate again in the coming months.

With data slightly better in May than in April, there is less need for action. Purchasing managers' index surveys on Wednesday showed that euro zone business activity shrank in May, but at a slightly slower pace.

Downturns have eased in France, Italy and Spain, and Germany is stabilizing, the data showed.

Inflation, which fell to 1.2 percent in April, rose back to 1.4 percent in May, closer to the ECB's target of just below 2 percent, while Eurostat confirmed that the bloc's economy contracted by 0.2 percent in the first quarter of the year from the October-December period.

STAFF PROJECTIONS

Analysts expect only minor changes to the ECB's outlook.

"They will revise down GDP growth forecasts, while we expect next year's inflation forecast to remain unchanged," Unicredit economist Marco Valli said, adding that he expected Draghi to maintain a dovish tone.

The central bank will continue to see a recovery later this year but not rule out further policy action, if needed.

"Draghi will try to balance two messages. He will try to sound constructive about the economy and to also leave the door open to further policy easing," JP Morgan economist Greg Fuzesi said in a note to investors.

One door the ECB will not close is the option of taking its deposit rate into negative territory from zero now - even though few analysts believe it has immediate plans to do so.

At last month's post-rate decision news conference, ECB President Mario Draghi said the central bank will look at negative deposit rates "with an open mind and we stand ready to act if needed".

But that might be ammunition the ECB wants to keep unused - at least unless the economy enters a downward spiral.

"It's not never-ever, but probably a lot would have to happen for it to happen," ABN Amro's Kounis said.

Varying borrowing costs in different parts of the common currency area have developed into a major headache for the ECB, with firms and consumers in the debt-ridden south having to pay much higher interest rates than their counterparts in the north.

After months of hinting at action to help especially small- and medium-sized enterprises (SMEs), the bloc's economic backbone, the ECB has lately sought to temper expectations, warning against expecting a bazooka.

ECB Vice-President Vitor Constancio said last week that one should not "overblow" options the ECB has to repair the market for asset-backed securities, which could help access to funding when bank-lending channels are blocked.

European Council President Herman Van Rompuy said on Friday he expected a joint proposal with the European Investment Bank to improve SME financing this month, although the ECB seems content to be a junior partner in any such scheme.

(Editing by Catherine Evans and Susan Fenton)

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