 Angela Merkel's party failed to secure a majority |
Investors have expressed dismay at the inconclusive outcome to Germany's general election, sending the euro and share prices lower on Monday. A "grand coalition" between the ruling Social Democrats and rival Christian Democrats looks likely after neither party won a majority in Sunday's vote.
German shares fell 2% but recovered slightly as both parties said they were exploring options to form a government.
Investors fear a period of political deadlock that would stall reforms.
After falling more than 100 points, Frankfurt's benchmark Dax index was trading down 40.10 points, or 0.8%, at 4946.40, by early afternoon.
Earlier, the euro had fallen to a monthly low against the US dollar.
No mandate?
Economists believe sweeping reforms are needed to tackle Germany's economic problems and that Sunday's result - in which the opposition Christian Democrats (CDU) secured three more seats than the Social Democrats - has not provided a clear mandate for change.
Both Chancellor Gerhard Schroeder and Christian Democrat leader Angela Merkel said on Monday they had made contact with other parties as a first step in trying form a governing coalition.
Negotiations could continue for several weeks, experts believe.
Financial analysts said the political uncertainty was bound to have a negative impact on market confidence.
Valerie Plagnol, chief economist at CM-CIC Securities, called the result "the worst case scenario for markets".
"There is no certainty whatsoever on whether these parties can agree to form a coalition, whether this coalition can agree on an economic programme, and if this programme will at least be a continuation of the reforms initiated by Schroeder," she added.
Tough decisions
Finding a cure for German's economic problems - which resulted in unemployment hitting a post-war high of 5.2 million earlier this year - was the major issue of the campaign.
Critics of Chancellor Gerhard Schroeder believe his labour market reforms - which have made it easier for firms to hire and fire staff - have not gone far enough.
Chancellor Schroeder claimed that policies put forward by Christian Democrat leader Angela Merkel on tax and labour reform went too far.
Indeed, Paul Kirchhof - Ms Merkel's main adviser on tax issues and a man blamed in some quarters for scaring voters with plans for a flat tax - has withdrawn from politics and back into academia following the election.
Investors are worried that a coalition government may shrink from tough decisions on the economy.
"This does nothing for the prospect for reform, in Germany or Europe in general," said Rob Henderson, an economist at the National Australia Bank.
Reforms on hold?
Fundamental change to Germany's tax system - which was proposed by the Christian Democrats - was now highly unlikely, one economist said.
"I would not expect any far-reaching reforms like the flat tax to be planned let alone executed in this parliamentary period," Dr Norbert Walter, chief economist at Deutsche Bank, told the BBC.
Dr Walter said the prospect of a diverse coalition government meant that labour reforms were likely to be "timid rather than bold".
"I believe people believe they can buy time which they can't," he added.
"Germany will not be a benchmark for reforms in Europe."
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This is the worst case scenario for markets
