(Updates with Wolfowitz resignation, quotes)

By Carol Giacomo and Lesley Wroughton

WASHINGTON, May 17 (Reuters) - The ouster of Paul Wolfowitz as World Bank president, in another rift between the United States and its European allies, poses an unprecedented challenge to U.S leadership of the global financial system.

Weakened by chaos in Iraq, low popularity and his lame-duck status, President George W. Bush was unable to prevent Wolfowitz's forced departure -- the first of a World Bank president -- after weeks of resistance and public acrimony over his promotion of a companion.

Some U.S. officials and experts expressed alarm that the controversy could force the United States to give up its World Bank preeminence and long tradition of appointing the president.

Others argued that a radical overhaul of the system of selecting the president and bank lending policies is the only way for the institution to regain credibility.

"There is growing discomfort with this idea that the United States should hand pick the World Bank president with no consultation," said Kenneth Rogoff, former chief economist at the International Monetary Fund.

Rogoff, a visiting fellow at the Brookings Institution, said that while Wolfowitz may be brilliant, he had little experience in development, poverty-fighting and finance and would not have been chosen in the first place if the selection process was transparent and open to others.

The United States, the bank's largest shareholder, has named the World Bank chief since it led the establishment of the post-World War Two international finance system at the Bretton Woods conference in 1944. As a trade-off, Europe picks the International Monetary Fund leader.

Wolfowitz was always a controversial choice because of his role as U.S. deputy defense secretary and intellectual architect of the Iraq war.

European allies, who grudgingly acquiesced to Wolfowitz's appointment as president only two years ago, reversed course in recent weeks and stubbornly insisted he go, despite a vigorous White House defense.

The White House said Bush had "reluctantly" accepted Wolfowitz's resignation. "Paul Wolfowitz is a good man who is passionate about the plight of poor people in the world. We would have preferred that he stay at the Bank," White House spokesman Tony Fratto said.

"MUCH LARGER NOVEL"

Wolfowitz had resisted heavy European pressure to resign as he sought to clear his name in negotiations with the bank's board over a possible exit strategy.

Wolfowitz's handling of the promotion and pay raise for his companion, bank employee Shaha Riza, was the immediate cause of the storm but many saw it as a proxy for other complaints.

"Wolfowitz was shoved down everyone's throats in 2005 and the only reason it succeeded was because the Europeans and Americans were hoping to turn a page" after the 2003 U.S. invasion of Iraq, said Ivo Daalder, co-author of "America Unbound" on Bush's foreign policy during his first term.

Bush had been re-elected in 2004 "and the Europeans figured they had to live with him for another four years so why oppose him on this," Daalder said in a telephone interview.

He argued that a bank report this week accusing Wolfowitz of ethical lapses was also an opportunity to make a broader case that "the Bush administration has misbehaved internationally. ... It is a subplot in a much larger novel about Europe versus the U.S. in the Bush era," Daalder said.

James Steinberg, a deputy national security adviser for former President Bill Clinton, said Washington would not necessarily lose much global influence by accepting a non-American as president of the World Bank.

As long as Wolfowitz's successor "could work well with the United States, the fact of it being an American is far less important. ... We need someone who shares basic views of development with the U.S," said Steinberg, dean of the Lyndon B. Johnson School of Public Affairs at The University of Texas at Austin.

But a White House official said: "There will not be a change in the tradition of how World Bank presidents are chosen."

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