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By Sarah White

MADRID (Reuters) - Spain's Socialists were set to pick a new leader on Sunday as the opposition party, hit by the rise of upstart leftist movements threatening its chances in a looming general election, tries to reshape and win back voters.

Support for Spain's two dominant political forces, including the centre-right People's Party (PP) now in power, has plummeted after a six-year economic downturn and corruption scandals.

New anti-austerity and anti-establishment parties tapping into that disenchantment have further fragmented the Left, and the Socialists suffered their worst-ever election showing in a European Parliament vote in May, pushing leader and Socialist veteran Alfredo Perez Rubalcaba to quit.

His replacement will have to rebuild the party in time for next year's election as a credible challenger to the PP, which beat the Socialists in 2011 with an absolute majority.

After wielding deep cuts in public spending, the PP of Prime Minister Mariano Rajoy was also punished by voters in May, but still came first.

The Socialists have struggled to overcome criticism of how their last government handled the economy when the crisis began, and competition among leftist parties is an additional headache.

"They (the Socialists) have to decide in which part of the political spectrum they want to position themselves," said Fernando Vallespin, political scientist at the Autonomous University of Madrid.

The party had probably permanently lost some votes to newer leftist parties, leaving it to try and wrest back more of the middle ground from the PP, he said, adding: "They are still far behind ... and will have to pass through purgatory before getting back to what they once were."

The three-way Socialist leadership contest will be decided by party militants, and two front runners have emerged in recent weeks. One is Eduardo Madina, 38, from the Basque Country who leads the Socialists in the lower house of parliament. He survived a 2002 bomb attack by ETA separatists, though lost a leg.

The other is Pedro Sanchez, 42, a photogenic economist who burst into the limelight in recent weeks. The Madrid-born parliamentarian gathered the greatest numbers of endorsements from militants to become a candidate.

Philosophy professor Jose Antonio Perez Tapias, 59, who is seen as favouring a greater shift to the Left than his rivals, is also in the running.

TWO PARTIES SHAKEN

Spain's economy returned to growth in the second half of 2013, but persistently high unemployment, with one in four workers out of a job, means many are not yet feeling the recovery and disillusionment with mainstream parties has grown.

That is starting to shake the dominance of the PP and the Socialists, who have essentially shared power since Spain returned to democracy in the 1970s after the dictatorship of Francisco Franco.

New leftist party Podemos (We Can), which grew out of anti-austerity protest movements and whose leader Pablo Iglesias often takes aim at political elites, was a big winner in the May European elections, taking a surprise 8 percent of the vote.

The People's Party scored 26 percent of the vote, the Socialists 23 percent and a coalition including far-left United Left took 10 percent.

Once their new leader is on board, the Socialists are still set to hold their first open primary vote, expected at the end of 2014, to choose a candidate for the general election.

The party will likely lose no time in trying to rebuild its image, also tarnished by a scandal in the traditional Socialist stronghold of Andalusia in the south of Spain, where it has been accused of skimming jobless benefits.

The Socialists have struggled to gain politically from a party financing scandal that has hurt the PP and its leaders.

(Reporting by Sarah White and Inmaculada Sanz; Editing by Lynne O'Donnell)

Reuters