Europe must solve its sovereign debt crisis so as not to endanger the uneven global economic recovery, which is led by China and emerging economies, central bankers said on Sunday.

Central bank officials gathering at the annual meeting of the Bank for International Settlements are confident the world economy is recovering thanks to huge liquidity injected by them through the worst of the financial crisis. But now paths have diverged, leading to a multispeed economy. Some central banks -- such as Australia, Israel, Norway and Brazil -- have tightened policy, while rates in the biggest economies are seen on hold at record lows until next year.

Europe is the main underperformer as it suffers from the effect of drastic fiscal spending cuts. Some weakness is also emerging in the U.S. economy, with first-quarter growth coming in slower than originally estimated.

This is leaving China, which introduced more flexibility to its yuan currency by letting it rise to a five-year high this month, to do much of the heavy lifting.

The global economy is showing a multi-speed recovery, with emerging markets particularly those in Asia seen to lead this recovery, Amando Tetangco, governor of the Philippine central bank, told Reuters.

Theoretically, there is going to be some significant impact (on growth) but that will depend on how leaders of Europe will be able to contain the crisis by putting in some programme that will win the confidence of the market. It's going to be a delicate balancing act.

Ways to support economic growth at a time governments around the world slash fiscal spending are expected to be high on the agenda at the three-day meeting in the Swiss city of Basel.

The meetings, which end on Monday, involve representatives from about 100 central banks and international organizations, including European Central Bank President Jean-Claude Trichet and U.S. Federal Reserve Chairman Ben Bernanke.

Central banks are fretting about a massive run-up in public debt in major economies as governments tried to spend their way out of recession, with debt outweighing economic output in many industrialized nations.

Former ECB policymaker Tommasso Padoa-Schioppa told the meeting the root of the financial crisis lay with governments, which had believed too strongly in the self-regulating power of the markets and focused too much on their domestic economies, rather than taking a global view.

The crisis is still with us and, like the HIV virus, it shows a pertinacious capacity to renew its destructive potential through continuous mutation, he said.

Romanian central bank Governor Mugur Isarescu said most of the discussion on Sunday was about regulation and banking supervision, adding that central bankers were not alarmed.

REBALANCING WORKING?

High yields on government bonds in eurozone peripheral nations like Spain, Greece and Portugal -- despite the presence of a safety-net -- highlight investor nervousness about high debt and deficits as debt outweigh economic output.

The euro zone is strong economic area, they have to sort out this problem, Njuguna Ndung'u, Kenya's central bank governor, told Reuters.

A week before the meeting, China loosened the yuan's 23-month-old peg to the U.S. dollar, which would help boost spending in the world's third-largest economy and increase its demand for foreign goods, giving a much-needed boost to a global recovery.

China is the main driver of growth in the global economy now. China is re-orienting itself toward the domestic economy, the Philippines' Tetangco said.

The (yuan reform) is really a sign that China authorities are more confident that the recovery is on a solid footing. That should be positive for us in Asia.

Taiwan's deputy central bank governor Chou A-Ting said the yuan's reform will affect Asian currencies, adding however that it was not the case for the New Taiwan dollar as local factors were the key driver there.

Another potential risk to the economy is the extent of tough new rules for the financial sector, which banks have warned risk crimping growth because banks will have to hold more capital and will therefore be less able to lend to firms and households.

In a concession to the still-fragile sector, Group of 20 leaders meeting in Toronto agreed to a flexible timetable for banks to adopt toughened capital rules, according to a draft communique seen by Reuters.

Insurance supervisors were hopeful policymakers would listen to appeals not to include insurers from any regulatory clampdown.

It's not the insurance business which creates systemic concerns, Yoshihiro Kawai, secretary general of the International Association of Insurance Supervisors, told Reuters.

We stress very much the different business model and that insurance is not an originator or amplifier of risks ... that's quite well heard by our political masters and the G20, FSB (Financial Stability Board.)

(Additional reporting by Ian Chua, Sven Egenter and Catherine Bosley, editing by Martin Golan)

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