* Leiderman cites privacy concerns in dropping out
* Prime minister seeks third candidate for vacant spot (Adds Bank of Israel spokesman on Flug's status, paragraph 12)
By Ori Lewis
JERUSALEM, Aug 2 (Reuters) - In an embarrassment for Israel, Leo Leiderman announced on Friday that he was withdrawing his candidacy to become the next governor of its central bank, the second nominee to pull out within less than a week.
Leiderman, chief economist at Bank Hapoalim, told Prime Minister Benjamin Netanyahu that he did not want the glare of publicity that came with the leading role at the Bank of Israel.
"After holding intensive discussions with his family over the past two days, he has decided that he would prefer to continue to work as a private person at Tel Aviv University and at Bank Hapoalim," said a statement released on Leiderman's behalf.
Netanyahu put forward Leiderman's name on Wednesday after the nominee for the vacant position, Jacob Frenkel, dropped out denouncing a "witch hunt" over media reports of a suspected shoplifting incident in Hong Kong in 2006. No charges were ever filed and Frenkel said it had all been a misunderstanding.
Netanyahu has had months to find a replacement for the highly regarded Stanley Fischer, who announced in January that he would step down at the end of June, two years early after spending eight years in the job.
Leiderman's announcement came just ahead of the Sabbath in Israel and all markets were closed. Analysts said Israel's monetary policy was on a steady course but urged a swift solution to the problem.
"It's a setback. It really heightens uncertainty," said Daniel Hewitt, emerging markets economist at Barclays Capital. "Now, we don't know what's going to happen with monetary policy in the near term."
Leiderman's decision to stand aside represented a remarkable turnaround. Just a day earlier, the Argentine-born economics professor had told Israel's top-selling daily, Yedioth Ahronoth, that he was ready for the job.
"Give me a hundred days of grace and then you will see that we will start to see results," Leiderman told the newspaper.
Leiderman's appointment had drawn the attention of Israel's Channel 10, which said he had regularly used to consult an astrologer. The television station quoted him as saying that the consultations were only for "personal and family matters."
The previous front runner for the position, Deputy Bank of Israel Governor and acting central bank chief Karnit Flug who was passed over for the job, quit on Wednesday but a spokesman said she would remain in charge until a new governor is named.
"Flug will remain acting governor until a permanent governor takes office," Bank of Israel assistant spokesman Yoav Soffer said.
The head of the main Labour opposition party Shelly Yachimovich had criticised the decision to nominate Leiderman, suggesting that Flug had been ignored because she was a woman.
Hewitt said Flug remained the best candidate.
"They should have gone with Flug in the first place," he said. "I really hope she reverses her decision."
Jonathan Katz, a Jerusalem-based economist, also said Flug should do the job, adding that financial markets had liked Fischer's policies and would expect her to continue in the same vein.
"She may cancel her decision to stand down that now that she appears to be the main candidate ... after 25 years' experience, a number of them as Fischer's deputy, the markets would be fairly pleased to have her in the job," he said.
Flug was not immediately available for comment. (Additional reporting by Steven Scheer; Editing by Crispian Balmer/Ruth Pitchford)