* Institutes cut 2012 German GDP growth f'cast to 0.8 pct
* See ECB cutting rates to 1.0 pct as recession threatens
* See German inflation dropping to 1.8 pct in 2012 (Adds details, background)
By Sarah Marsh
BERLIN, Oct 13 (Reuters) - The greatest risk to Germany's economy is a worsening of the European debt crisis which could lead to tighter credit conditions, leading economic institutes said on Thursday in their keenly-eyed twice-yearly report.
The eight institutes, which are seen as influential policy advisers to the German government, cut their growth forecast for Europe's bulwark economy to 0.8 percent next year. In April, they had forecast 2.0 percent.
"The debt crisis in Europe is threatening to become a banking crisis which is increasingly weighing on the German economy too," the institutes said.
"The strongly increased uncertainty will dampen domestic demand and foreign trade will probably no longer contribute to the expansion due to the difficult situation of important trade partners."
Germany's export-driven economy has recovered swiftly from the financial crisis, outperforming its peers and providing a crucial growth engine and anchor of stability for Europe.
Recent indicators however show German growth easing due to the global slowdown and the euro zone's debt crisis. Industry output, orders and retail sales slumped in August.
Forward-looking indicators are also gloomy, with business sentiment dipping to its lowest level since mid-2010 in September, and analyst sentiment dropping to its lowest level in nearly three years.
However, an unexpectedly strong start to the year will likely compensate for a weaker second half, and the institutes slightly raised their 2011 growth forecast to 2.9 percent from 2.8 percent.
They were also more upbeat on inflation, which presented a challenge to the European Central Bank this year as it sought to balance monetary policy for struggling debtor economies and for booming Germany.
The institutes saw German inflation dropping to 1.8 percent next year from 2.3 percent in 2011. Data last month showed inflation jumping unexpectedly to a three-year high of 2.6 percent in September.
Due to lower inflation expectations and the growing risk of a European recession, the European Central Bank will likely cut interest rates to 1.0 percent, the institutes said.
The institutes see unemployment continuing to fall despite the generally worsening outlook. The jobless rate will likely fall to 6.7 percent in 2012, from 7.0 percent in 2011.
Germany's government plans to publish its own economic forecasts on Oct. 20, which will serve as the basis for its November tax estimates and the budget planning.
For a factbox on recent revisions to forecasts for German economic growth, please click on (Reporting by Madeline Chambers and Sarah Marsh; Editing by Ruth Pitchford)