By Stephen Brown and Erik Kirschbaum

BERLIN (Reuters) - Peer Steinbrueck, an abrasive former finance minister, will lead the German Social Democrats' challenge to unseat chancellor Angela Merkel in a parliamentary election a year from now.

Announcing their "chancellor candidate" some months earlier than expected, the centre-left opposition took Germany by surprise on Friday; Steinbrueck, a combative veteran from the right of the SPD, marked out a campaign theme of tougher rules for banks and a goal of coalition government with the Greens.

Analysts saw his rapid emergence from a three-way struggle within his party as the outcome most threatening to Merkel, though polls show the conservative leader still well ahead.

Steinbrueck led Germany's response to the global economic crisis while serving as finance minister in Merkel's first government, a grand coalition from 2005-09. But the 65-year-old dismissed talk of forming another left-right pact, however the parties fare in a vote for the Bundestag due by October 2013.

"We want to oust this government. We want to make sure it isn't just partially replaced but completely replaced with an SPD-Greens government," he told a news conference, referring to the ecologist party currently ranked third in opinion polls.

The path was cleared for Steinbrueck's candidacy after two other SPD contenders, party chairman Sigmar Gabriel and former foreign minister Frank-Walker Steinmeier, stepped aside.

The election is no presidential style face-off but is fought by parties for parliamentary seats on the basis of proportional representation. However, the two traditional big parties set the tone for their campaigns according to their choice in advance of who will lead a government if they win a legislative majority.

Known for a quick wit and acerbic tongue, Steinbrueck is likely to mount much sharper attacks on Merkel than the more diplomatic Steinmeier and could also siphon away votes from her Christian Democrats (CDU) because of his centrist economic views and reputation as a safe pair of hands.

"Steinbrueck is definitely the most dangerous candidate because he appeals to the voters in the middle," said political scientist Gero Neugebauer at Berlin's Free University.

But a poll by Politbarometer released on Friday showed much higher personal support for Merkel. The 58-year-old chancellor, whose reputation has been much enhanced in the euro crisis, had a 53 percent approval rating versus Steinbrueck's 36 percent.

Merkel's spokesman Steffen Seibert said the chancellor has "no preference for who runs against her" in the 2013 campaign.

A native of the rich northern port of Hamburg and once prime minister of Germany's most populous state, the western industrial powerhouse of North Rhine-Westphalia, Steinbrueck has never won a major election. He took over as state premier in mid-term. And, at the federal level, it was Steinmeier who was the SPD candidate against Merkel in 2009. He suffered a crushing defeat in which the SPD vote hit a postwar low of 23 percent.

The outspoken Steinbrueck has vowed that he will never again serve in a Merkel cabinet. He seems likely to resist a revival of the grand coalition, in which the SPD was junior partner - an experience which saw the party's popularity ravaged.

TAKING ON THE BANKS

Steinbrueck's launch this week of proposals for tough new restrictions on the banking sector have mollified some critics on the left wing of the SPD.

"Steinbrueck has taken a big step in our direction by being very bold in taking on the powerful and aggressive bank lobby," said Ernst Dieter Rossmann, a leader of the SPD left in the Bundestag lower house. "He's got our full support on that."

As Germany's oldest active party celebrates its 150th anniversary next year, it stands at around 26 percent in opinion polls compared with 38 percent for the Christian Democrats.

But the poor standing of Merkel's centre-right partners, the Free Democrats who are languishing at 4 percent, may force her to seek another coalition partner - possibly into an alliance with the SPD or, somewhat less likely, with the Greens.

The SPD insists its goal is to lead the next government with the Greens. Together they score about 43 percent in polls and would need about 47 percent of the vote to form a parliamentary majority. Parties with less than 5 percent get no seats at all.

Steinbrueck hopes to tap into public anger at banks' perceived recklessness and culpability for the financial crisis.

"This is not about destroying the financial system, rather it is about stabilizing it and preventing future excesses, and preventing any repeat of what we have seen in the past few years," he said when presenting his banking plan this week.

If Steinbrueck wins office he would seek a special bailout fund for banks, financed by banks themselves so that taxpayers no longer have to rescue the financial sector.

In proposals criticized by Deutsche Bank, he also wants to separate banks' retail and investment banking operations in order to safeguard household depositors' money.

The pro-euro SPD has supported Merkel's response to the euro zone crisis but Steinbrueck favors even deeper integration in Europe, such as common debt issuance in the currency bloc. This is firmly opposed by Merkel and unpopular with many Germans.

Steinbrueck, endorsed by both living former SPD chancellors - Helmut Schmidt and Gerhard Schroeder - is a straight talker with a record of verbal clashes, at home and abroad. The Swiss took exception to him likening them to "Indians" fleeing the cavalry during a row about tax havens. And current finance minister Wolfgang Schaeuble responded to his heckling in parliament last year by telling him to "learn some manners".

A senior official who knows him well said: "Steinbrueck says what he thinks. Ninety percent of the time it's a strength.

"The other 10 percent it gets him in trouble."

It is unclear he will change his style to lead the campaign. An avid chess player, Steinbrueck once said of his style on the board: "I often play very impulsively."

(Additional reporting by Andreas Rinke, Gareth Jones and Holger Hansen; Writing by Stephen Brown and Erik Kirschbaum; Editing by Noah Barkin and Alastair Macdonald)