BERLIN (Reuters) - German Chancellor Gerhard Schroeder vowed not to give up his post without a fight after his party was pipped by Angela Merkel's conservatives in a tight election, setting the stage for weeks of political turmoil.
Energised by a vote that put them just three parliamentary seats shy of Merkel's conservatives despite forecasts of a blow-out, Schroeder's Social Democrats said they were ready to talk with everyone on forming a new government.
Merkel echoed the line, telling reporters: "We have the mandate to form a government. We are clearly the strongest party."
But the SPD had lost none of its election-night bombast on Monday, insisting that no coalition was possible without Schroeder at the top -- akin to calling for the conservatives to topple Merkel, whom he had publicly taunted on Sunday night.
"It is clear that Germans do not want Mrs Merkel as their chancellor," SPD chief Franz Muentefering told a news briefing. "We have a responsibility to make clear that we want to rule with Mr Schroeder as chancellor and implement much of that which we have undertaken to do."
The election left both main parties too weak to secure a majority with their natural coalition partners -- Merkel with the liberal Free Democrats who share her radical economic reform goals; and Schroeder with the Greens who have ruled with him for seven years, and like the SPD portray themselves as guardians of the welfare state.
Even after a bitter campaign in which Schroeder painted Merkel as a cold radical bent on dismantling the welfare state and the conservatives labelled him a liar, many analysts believe a "grand coalition" between the two largest parties is the most likely outcome to Sunday's debacle.
But with Merkel and Schroeder both claiming a mandate to rule and personal hostilities between the two leaders at a high point, an agreement between them looks far off -- and the prospect of more exotic, unforeseen alliances has begun to loom.
BLOW TO REFORMS
The unprecedented uncertainty weighed heavily on financial markets, which had hoped for a clear reform mandate for the Merkel's Christian Democrats (CDU), their sister Christian Social Union (CSU) and the FDP.
They had been vowing deep economic reforms, including cuts in payroll costs, easing of firing rules and a simplification of the tax system.
The euro currency slumped to a 7-week low against the dollar on Monday, while German stocks shed 1.2 percent, underperforming shares across Europe.
"The stalemate that emerged in the election is of course the worst result that you could have wished for, the worst for the interests of Germany and for Europe," European Central Bank Governing Council member Klaus Liebscher, who heads Austria's central bank, told reporters in Vienna.
Bank of America economist Holger Schmieding predicted a slowing of economic reform, regardless of what government eventually emerged.
The parties will try to agree a majority government by Oct. 18, when the new parliament must meet.
The weeks leading up to that date will be characterised by grandstanding and hard-nosed politics, as the SPD, CDU/CSU and their potential partners, the FDP and Greens, manoeuvre.
The stalemate prompted talk of coalitions that have never been seen before in Germany. The only plausible alternatives to a grand coalition involve either the CDU/CSU or the SPD managing to draw both the leftist-environmentalist Greens and the free-market FDP in from opposite ends of the spectrum.
Leaders of both the Greens and the FDP vowed on Monday not to be lured into a three-way coalition.
But sources told Reuters the SPD leadership had decided to push hard to convince the FDP, partners of the conservatives since 1982, to switch camps.
"We have points in common with the FDP, particularly when it comes to tax," SPD Interior Minister Otto Schily said.
FOREIGN REACTION MIXED
The long-term impact of the election on German foreign policy is unclear, although Turkey revelled on Monday in Merkel's failure to secure a clear victory.
Unlike Schroeder, Merkel opposes Turkish entry into the European Union, and Turkey had feared a clear win for her would have doomed its long-standing bid to join the 25-nation bloc
"It was an auspicious result for the EU process," Turkish Prime Minister Tayyip Erdogan said.
In other countries, the reaction was less cheerful.
In an editorial headlined "The worst result", Britain's Times newspaper said the uncertain outcome was "probably the worst possible for the country and for the cause of reform".
The Italian newspaper Il Messaggero wrote: "If this is a foretaste of a future trend in Europe, there is nothing to be cheerful about."