FRANKFURT The European Central Bank should reduce the amount of interest it pays commercial banks on reserves held with it, Bundesbank President Joachim Nagel said on Friday, and keep open the option of further rate hikes as inflation remains too high.

With lenders earning generous profits at the expense of the central bank, some policymakers have called on the ECB to cut the interest it pays on the funds banks park with it overnight.

Such a move, they say, would dampen banks' appetite for lending and save on taxpayer funds.

The ECB has so far pushed back on those calls, arguing that a framework review next spring is a more appropriate occasion for such a discussion and the benefit of forcing banks to hold more unremunerated reserves was not obvious.

Nagel, a powerful voice in the 26-member Governing Council, argued that banks enjoying generous interest on their excess reserves tend to lend more, impeding the ECB's efforts to curb inflation via tighter monetary policy.

"The minimum reserve requirement is a tried and tested monetary policy instrument that could help to counteract this effect," Nagel said.

"At this point, I see no reason to rule out a moderate increase to improve the efficiency of monetary policy," he said. "Just to remind you, over the first 13 years of the euro, the minimum reserve ratio stood at 2%."

Banks are now required to keep just 1% of certain customer deposits at the ECB, earning no interest, while the rest of their reserves earn the ECB's record high deposit rate of 4%.

An increase in the minimum reserve requirement back to 2% would be a modest change at the lower end of numbers discussed by ECB policymakers and far below the 10% rate advocated by Austrian central bank Governor Robert Holzmann.

The ECB's problem is that inflation, though down to 2.9%, could yet rise again and is forecast to take until late 2025 to fall back to the central bank's target of around 2%. That is despite ten back-to-back rate hikes that lifted the deposit rate from negative territory to 4% by September.

Such a drawn out disinflation process raises the risk that price growth gets stuck above the ECB's target, prolonging the period of tight monetary policy.

"Are we there yet? Have we seen the peak in interest rates? That is not clear yet," Nagel said.

He also pushed back against ECB critics who say the bank has overdone rate hikes, arguing there was no evidence of overtightening.

"Dampening aggregate demand does not necessarily mean inducing a recession," Nagel said. "I am optimistic that we can avoid a hard landing of the economy."

(Reporting by Balazs Koranyi; Editing by Kirsten Donovan)