* Germany raises 2010 growth forecast to 1.2 percent
* Outlook for exports, labour market brighter
* Financial sector stability remains "major challenge"
By Noah Barkin
BERLIN, Oct 16 (Reuters) - Germany revised up its gross domestic product (GDP) forecasts for 2009 and 2010 on Friday, saying Europe's largest economy had emerged from its deepest post-war downturn in the summer and was on a recovery path.
The economy is now expected to contract by 5.0 percent in 2009, compared to a forecast drop of 6.0 percent last April, and grow by 1.2 percent next year versus a prior forecast for meagre growth of 0.5 percent, the Economy Ministry said.
"The German economy emerged from its lowpoint in the summer after a year of contraction," Economy Minister Karl-Theodor zu Guttenberg said in a statement. "The chances are good that we can build on the upward trend next year."
The new forecasts reflect a brighter outlook for exports, the key driver of the German economy in past years, and more optimistic view on the labour market.
They are welcome news to Chancellor Angela Merkel and the new centre-right coalition she is expected to lead from next month. Stronger growth will help the new government in its efforts to reduce a soaring deficit and debt levels and possibly give them more room to pursue tax cuts.
The ministry now expects exports to rise 4.3 percent in 2010, compared to an April forecast for growth of 0.9 percent. It expects the unemployment total to rise to 4.1 million next year, well below an April forecast for 4.62 million.
A government part-time work scheme, which encourages companies to reduce the hours of their workers instead of firing them, has prevented the mass layoffs seen in some other European countries.
"Negative forecasts made at the height of the economic crisis that unemployment would rise above 5 million now look entirely unlikely," Guttenberg said. "Employment has held up much better than was feared because of the dramatic economic downturn."
Despite the improved outlook for the labour market, the ministry stuck with its forecast for private consumption to dip 0.3 percent in 2010.
Guttenberg said the chances of recovery now outweighed the risks of another economic setback for Germany, but he also warned about the fragility of the country's banks and cautioned that government efforts to support the economy and financial markets must be unwound wisely.
"The strengthening of the banking and financial sector remains a major challenge," he said.
(Writing by Noah Barkin; Editing by Toby Chopra)