The euro tumbled and German shares slid yesterday as Germany's general election gave Angela Merkel's conservatives a victory so narrow that chancellor Gerhard Schröder refused to concede defeat.
Market fears of a political deadlock destroying any chance of reform in Europe's largest economy drove the euro one per cent lower to a new seven-week low against the dollar in early trade, while stocks in Frankfurt fell nearly 2 per cent at the start.
Analysts said the stalemate resulting from the most inconclusive post-war German election result was likely to weigh on the euro until a clear political alliance emerged to head a new government strong enough to push through reforms.
"The failure to get a decisive vote in the German elections has left uncertainty, and the first rule of markets is that they don't like uncertainty," said Joe Francomano, vice-president of foreign exchange at Erste Bank in New York.
But the euro-selling may be a knee-jerk reaction, Citigroup strategists said.
"Markets may continue to overestimate the degree to which a grand coalition represents a set-back to the reform process, but progress toward structural reform is only likely to come after a modicum of clarity is restored to politics," they wrote in a note to clients yesterday.
German blue-chip shares were led lower by utilities as the election outcome raised fears of political paralysis in Europe's largest economy and diminished hopes for economic reforms.
The DAX of Germany's top 30 companies closed down 1.2 per cent at 4,926.13 points, after earlier falling to its lowest level in two weeks.
Analysts said they expected more volatility and setbacks for the DAX in coming weeks as the most likely scenario of a grand coalition of German chancellor Gerhard Schröder's SPD and the conservative CDU offered little appeal to financial markets.
"Investors will be wondering whether the SPD or the CDU will be calling the shots in a grand coalition, which means uncertainty," said Giuseppe Amato, a market analyst at brokerage Lang & Schwarz.
But investors said they took it as good sign that the DAX regained some ground in the afternoon, showing that many foreign funds were encouraged by the solid performance of most German blue chips in the second quarter.
