Resist early rate cut temptation, ECB's Nagel warns

FRANKFURT/MILAN (Reuters) -Euro zone inflation remains stubbornly high so the European Central Bank should resist the temptation to cut interest rates early, especially before crucial wage data in the second quarter, Bundesbank President Joachim Nagel said on Friday.

The ECB has kept interest rates at a record high since last September and consistently pushes back on rate cut talk, arguing that wage growth is still too quick for it to sound the all-clear and start unwinding restrictive policy.

"Even though it may be very tempting, it is too early to cut interest rates," Nagel said in a speech.

"We will only receive a more detailed picture of how domestic price pressures are unfolding during the second quarter. Then we can contemplate a cut in interest rates."

Isabel Schnabel, the other German on the 26-member Governing Council and another influential voice, was also cautious in her assessment on Friday, arguing that the final phase of getting inflation under control may be more difficult than some anticipate.

"We need to be cautious .. there are reasons for the last mile to actually be more difficult than the first phase," she told a university lecture in Milan.

She also argued that, with markets already anticipating rate cuts, financial conditions had already loosened substantially, unwinding some of the ECB's efforts and adding to the need for caution.

Market bets on rate cuts have been extremely volatile in recent weeks.

Investors were betting on 150 basis points of easing in 2024 just a few weeks ago, but expectations have receded and now stand at just 88 basis points with the first move seen in June.

HOPEFUL SIGNAL

The ECB has long argued that crucial figures on 2024 wage settlements will only come out in May, so the June meeting will be the first occasion policymakers will have evidence if rapid wage growth is slowing.

Sending a hopeful signal, Schnabel said that the ECB was already receiving some evidence that firms were starting to absorb some of the rapid wage growth, a potential piece of good news because it suggests that not all of the wage growth is translating into higher prices.

This would be a reversal from the early stage of rapid inflation when firms enjoyed strong pricing power and raised prices sharply to enjoy some of their best margins in years.

Inflation projections are also likely to come down because of lower energy prices and benign food prices, but that does not necessarily lower underlying price pressures.

Indeed, an early rate cut runs the risk of missing the inflation target and could, in an extreme case, force the ECB to raise rates again, a costly blunder, Nagel argued.

Nagel appeared especially worried about underlying price growth, which reflects broader price pressures in the economy, including wages and the crucial services sector.

"Inflation rates – especially the 'hard core' – will still remain markedly higher than 2% in the coming months," Nagel said.

The period of rapid decline in inflation was now over and setbacks were also possible, Nagel said, partly due to statistical effects, including the timing of holidays such as Easter, which impact how businesses price products and services.

(Reporting by Balazs Koranyi and Valentina Za; Editing by Alex Richardson)