German Chancellor Angela Merkel warned on Thursday that a U.S. drive to rebalance the global economy risked distracting the Group of 20 from a more urgent need for market regulation at their Pittsburgh summit.

Merkel's remarks in Berlin underscored differences between some of the world's largest economies as she, U.S. President Barack Obama and other G20 leaders headed for talks on Thursday and Friday on how to respond to the global financial crisis.

The sheer volume of problems the two-day summit is set to address -- from the lopsided global growth model to tougher rules for banks and bankers' pay, plus climate change -- prompted low expectations for any near-term action.

The United States, the world's largest economy and the epicenter of the global crisis, wants G20 countries to commit to reducing reliance on U.S. consumers by boosting consumption in exporting countries, such as China, while encouraging debt-laden nations such as the United States to save more.

I have made clear we should not look for other topics and forget about financial market regulation, Merkel said. Imbalances are an issue. We must have imbalances and all the possible causes on the agenda. Exchange rates belong to that.

Merkel, on track to win a second term in an election on Sunday, said the world's leading countries were making progress on financial reform and should not shy away from measures that might prove unpopular with the banking industry, where the economic crisis began.

Echoing Merkel, Japanese Prime Minister Yukio Hatoyama said his country wants to play a part in crafting global rules to rein in excessive money-making games.

MANY BRIDGES TO CROSS

G20 diplomats were trying to narrow differences over the U.S. proposal to rebalance the world economy and issues such as the pace of global trade talks, use of fossil fuels and the balance of power of financial institutions.

Export giant China has given only qualified support for the idea of improving global imbalances.

Rich countries were pressing big developing nations on Thursday to increase domestic demand but it was still an open issue, an Italian diplomat said.

A draft communique was half-completed. Officials agreed it would say there are signs the global recession is ending but it will also stress the need to continue with economic stimulus measures, the Italian diplomat said.

The International Monetary Fund has been urging G20 leaders to keep stimulus plans in place while millions of people who lost their jobs during the crisis remain out of work.

South Korea said it was too early to discuss an exit strategy. It's too premature. That's our absolute position, South Korean Finance Minister Yoon Jeong-hyun told Reuters.

In another sign of increasing stability, major central banks announced they planned to scale back massive injections of U.S. dollars into their banking systems that were part of efforts to shore up crisis-hit economies.

Separately, European sources said the United States was opposed to setting an early 2010 target date for a long-sought breakthrough in the Doha round of world trade talks.

European diplomats say the Obama administration is too focused on getting contentious plans for U.S. healthcare reform through Congress to risk further battles with lawmakers over a trade deal that could upset agricultural and business lobbies.

Downtown Pittsburgh was shut down as part of tight security measures, with National Guard troops and police officers at checkpoints, as leaders began streaming into the scenic city at the confluence of three rivers in western Pennsylvania.

Several hundred protesters gathered at a large park ahead of a march on the convention center where the G20 is meeting.

Holding something like this without public input isn't right, said Katy Slininger, 20, a media student.

One man held a large U.S. flag that had corporate logos for companies like McDonalds, IBM, Shell, Pepsi and General Electric in place of the stars.

Mark Sanderfer, 55, sat at a picnic table writing posters with slogans such as G20 greed x 20 = planets of slums.

The message here is when are you going to treat citizens of the world right? said Sanderfer, a project manager at a concrete construction company in Denver, Colorado.

BANK PAY UNDER SCRUTINY

France and Germany want curbs on bonuses they say fostered huge risk-taking and helped cause the turmoil on financial markets that shoved the world economy into recession.

Diplomats said talks were moving toward establishing an overall link between the profits a bank makes and the health of its balance sheet to the amount of money it can put into a pool for bonuses.

Now that the recession in many countries appears to be ending, the challenge is to sustain the sense of urgency felt in April when the G20 agreed to work together to rescue the world economy and pledged hundreds of billions of dollars to finance crisis-fighting by the IMF.

The U.S. Federal Reserve said on Wednesday that growth had returned to the world's biggest economy. U.S. workers filing new claims for jobless benefits fell last week but a drop in sales of existing homes in August provided a mixed picture.

The euro zone also appears poised to emerge from recession, although most economists expect only a gradual recovery. A key indicator of German business confidence fell short of expectations on Thursday.

(Reporting by Reuters G20 team; Writing by Steve Holland; Editing by Howard Goller and John O'Callaghan)

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