* Early EU reform pushed up pay, hardening resolve for stricter rules
* Bonus cap could hit top earners among London's 144,000 bank staff
* Lawmaker McCarthy: European Parliament will not budge on pay demands
* Decision not expected before 1800 GMT; might be deferred
By John O'Donnell and Alice Baghdjian
BRUSSELS/LONDON, Feb 27 (Reuters) - The European parliament and EU states could agree on Wednesday to impose caps on bankers' bonuses, a measure that would channel public fury at financial sector greed, but which opponents say marks a reckless overreach by Brussels into private pay deals.
Negotiations to introduce a cap on bankers' bonuses in the European Union resume on Wednesday, a week after European lawmakers and ambassadors from countries failed to reach a deal. A majority of states in the 27-member bloc would have to support a measure passed by the European parliament to make it law.
Limits to bankers' pay are popular on a continent still struggling to emerge from the ruins of a 2008 financial crisis. Lavish pay is blamed for encouraging bankers to take excessive risks, destabilising banks that then needed to be bailed out.
Banks and industry lobbyists have strongly resisted bonus caps. They say such limits would only force banks to hike base pay to keep staff, making wage bills less flexible.
Britain in particular is wary of any measure that might hurt the City of London, the continent's financial capital, with 144,000 banking staff and many more in related jobs.
But European lawmakers see a cap - possibly limiting bonuses to double base salary - as the only way to rein in runaway pay, reduce incentives for risk and make banks safer.
"A cap is the only way we will see bonus restraint," said Arlene McCarthy, the British member of the European Parliament who pushed for pay reform. "The parliament is not prepared to budge. Legislators have got fed up because they don't see any restraint in the bonus culture."
Talks between EU country ambassadors about the rules broke up last week amid clashes over how far to go. But tougher rules seem certain.
"There will definitely be a bonus cap," said one official. "It's just a question of how much."
A decision is not expected before 1800 GMT and there is a possibility that it might be deferred for more negotiations.
Britain, anxious to protect a sector that accounts for one tenth of its economy, is trying to dilute the impact of the cap with proposals that would allow higher bonuses if they were paid in share options.
Nearly 700,000 people work in financial and professional services in London. About 27 billion pounds ($41 billion) of bonuses have been spent over the last decade on real estate in the British capital, according to data compiled for Reuters by property firm Savills.
"If implemented, the new pay restrictions would lead to an exodus of bankers and traders to Switzerland and the Far East," Norman Lamont, a former finance minister from Britain's ruling Conservative party, wrote in the Daily Telegraph.
"Not to put too fine a point on it, the bonus cap is a piece of economic lunacy that reflects tellingly on why it was a huge mistake giving the pointless hybrid parliament in Brussels any legislative powers at all."
Many in banking argue that such reform will do little to lower pay in finance, where head-hunters say some annual packages in London approach five million pounds.
"This will only change the way that pay is structured," said Andrew Breach, a head-hunter at Michael Page, which recruits traders and other bankers. "This is not the civil service. This is a market driven industry. If you want people to make profit, then you need to reward them."
An earlier attempt to limit bankers' pay with an EU law forcing financiers to defer bonus payments over up to five years merely prompted lenders to increase base salaries.
However McCarthy, the European lawmaker, said it will be harder for banks to raise base pay this time around. The bonus rules will come as part of wider legislation setting higher capital standards for banks, increasing their costs and curbing freedom to hike salaries.
Hedge funds and private equity firms will be excluded from such curbs although they face restrictions on pay later this year under another EU law.
Bankers who spoke to Reuters are worried about the law but reluctant, like many of their employers, to speak openly about the reform.
The restrictions planned by Brussels, which could come into force from the beginning of next year, may, however, be overtaken by events in an industry where slack activity has already driven down most bonuses to twice salary or lower.
Having peaked in 2008 at 11.5 billion pounds ($17.40 billion), the bonus pool in London fell to 4.4 billion pounds last year, according to research by the Centre for Economics and Business Research. It predicts that pool will be just 1.5 billion pounds this year and fall further in the future.
On Wall Street, by contrast, the securities industry's bonus pool was expected to total $20 billion last year with the average cash bonus rising an estimated nine percent to almost $121,900, New York state's comptroller said this week.
The rosier climate for banking in the United States and Asia combined with the bonus cap from Brussels could be the final straw for some bankers.
"We have been talking for years about the economy and the regulatory environment here potentially moving people abroad and we haven't really seen it. But this might be enough to push a lot of people off the ledges," said one London-based headhunter.