UPDATE 1-Merkel points finger at Japan in currency war debate

* German leader says central banks must set limits

* Youth unemployment Europe's "biggest burden"

By Noah Barkin and Annika Breidthardt

Jan 24 German Chancellor Angela Merkel waded into a burgeoning debate about currency wars on Thursday, singling out Japan as a source of concern following recent moves by its central bank to quicken the pace of money-printing.

Central bankers in advanced countries, notably Japan and the United States, have been pursuing aggressive action to reflate their economies. This has the effect of weakening their currencies.

"I am not completely without worry," Merkel said at the World Economic Forum in Davos, when asked whether currency manipulation risked distorting competition.

"I don't want to say that I look towards Japan completely without concern at the moment," she added. "It is known that in Germany we are of the opinion that central banks are not there to clean up political bad decisions and a lack of competitiveness."

The Bank of Japan is under pressure from the country's new Prime Minister Shinzo Abe to take bolder action to overcome deflation and lift the economy out of recession. In recent months it has expanded its asset-buying programme and this week it doubled its inflation target to 2 percent.

The head of Germany's Bundesbank joined other central bankers this week in warning about the risk of competitive devaluations - countries encouraging their currencies to weaken in order to boost the attractiveness of home-grown products.

Jaime Caruana, general manager of the Bank for International Settlements, told Reuters Insider television in a Davos interview that central banks were coming under "excessive pressure" to promote growth and weaken currencies.

Merkel said it was important for central banks to set limits, as she said the European Central Bank had done in announcing its own bond-buying programme last year that is conditional on economic reforms.

"Central banks, too, will not be able to solve structural problems that stem from political decisions. They can build bridges," Merkel said.

"The European Central Bank has contributed to this but the ECB has also made clear, only those who implement structural reforms and accept conditionality, can hope for our support."

She said politicians in Europe now had an obligation to act, as the ECB had bought them time.

The 58-year-old German leader appeared to reject suggestions by other officials at Davos that Europe's austerity drive had gone far enough. She said politicians sometimes needed the pressure of a crisis to push through difficult reforms.

"My conclusion is therefore that if Europe is in a difficult situation today, we must implement the structural reforms today so we can live better tomorrow."

Yet she also referred to youth unemployment as Europe's "biggest burden" and said steps may be necessary to prevent political and social instability from breaking out.

"Our main task must be to present perspectives and possibly even to provide bridging measures until they lead to a decline in unemployment. That's what the near future is about," Merkel said.