Germany stuck in economic weakness but rate cuts should be gradual, Nagel says

FRANKFURT (Reuters) - Germany is stuck in a period of economic weakness but central bank interest rates need to come down only gradually to make sure inflationary pressures are fully extinguished, Bundesbank President Joachim Nagel said on Monday.

The euro zone's biggest economy has been the bloc's laggard in recent years and the outlook is bleak as export demand is lacklustre, its oversized industry is in recession and consumers are proving too cautious, building up savings instead of spending cash buffers.

"Germany is stuck in a period of economic weakness which has now lasted two and a half years," Nagel said in a speech.

"Stagnation is likely in the final quarter of this year," Nagel said, adding that this would mean negative growth and Germany would be falling behind the rest of the bloc.

While weak growth is a drag on consumer prices, Nagel also cautioned against quick ECB rate cuts, arguing that risks remain.

Wage growth may still prove too quick, underlying inflation is still high and trade policies of the new U.S. administration could prove inflationary, he warned.

"It is important to remain cautious and to loosen monetary policy only gradually and not too quickly," Nagel said.

Still, he added that the ECB is increasingly confident it will hit its 2% inflation target next year.

The ECB has cut interest rates three times this year and a fourth move on Dec. 12 is now fully priced in. Markets, however, are split over the magnitude of the cut with investors seeing a 40% chance the bank will opt for a 50 basis-point move instead of the usual 25, given weak growth.

The bank's 3.25% deposit rate is seen falling to 1.75% by the end of next year, a level regarded by many to be below the so-called neutral rate, suggesting investors are betting on the need for central bank stimulus.

(Reporting by Balazs Koranyi, editing by Ed Osmond)