Late results in Germany's general election showed that Ms Merkel's party had won only 35.1 per cent of the vote one of the conservatives' worst performances on record. It put her party a mere one percentage point, or three parliamentary seats, ahead of Gerhard Schröder's Social Democrats.
Although narrowly the strongest party, the conservatives' poor showing deprived Ms Merkel of the parliamentary majority needed to form the coalition government she had hoped for with Germany's liberal Free Democratic party, which won more than 10 per cent of the vote.
Clearly shocked by her party's performance, Ms Merkel insisted last night: "We have emerged as the strongest party in the election. We have a clear mandate to form the next government. I shall be holding discussions with all parties on how to form a stable coalition."
Mr Schröder, whose party won a far better result than predicted, refused to accept defeat and insisted he was still in a position to lead a government. "How can the Christian Democrats expect a leadership role after such a disastrous performance ?" he asked cheering supporters at his party's headquarters in Berlin. "There can only be a stable government under my leadership."
Earlier Mr Schröder had said that he would quit politics if his party failed to emerge as the strongest political force in the election. Political commentators said that in a secret parliamentary ballot needed to elect a chancellor to head the next government, Mr Schröder appeared to be banking on the clandestine support of the recently formed radical "Left Party" to remain in office.
Liberal Free Democrat leaders last night flatly refused to contemplate joining a coalition with Mr Schröder's previous government of Social Democrats and Greens. "We fought this election on a campaign to get rid of the red-green government. We are not going to join a coalition which will only prolong the misery," Guido Westerwelle, the FDP leader, told German television.
The Social Democrats have refused to enter into a coalition with the " Left Party", which won 7.5 per cent of the vote yet they were left without a big enough majority to continue governing with their Green coalition partners, who won 8.5 per cent of the vote.
As a result the most likely option Ms Merkel faced last night was a " grand coalition" government with the Social Democrats an arrangement hitherto rejected by both parties during the election campaign because of its inherent inability to agree on policy.
The other option open to Ms Merkel was a so-called "Jamaica coalition" comprised of Christian Democrats, Liberals and Greens. Joschka Fischer, the Greens party leader, said last night that he would hold talks with Ms Merkel, but admitted that the prospect of such an alliance was " unrealistic."
With the result so narrow and the composition of Germany's future government unclear, it appeared increasingly likely that the final outcome of the election could be determined by 219,000 voters in the east German city of Dresden, where polling has been postponed for two weeks following the sudden death of a candidate.
At conservative party headquarters in Berlin last night, party members said they were dismayed at seeing their hopes of a clear victory dashed at the polls. "I couldn't believe the result," said one CDU MP. "The outcome will shatter the party. It can only be seen as a chance to attempt a new beginning."
The result was a severe blow to Ms Merkel's standing as leader within her own party and it undermined her prospects as a future chancellor. Only a fortnight ago, opinion polls had predicted that her party was on course to beat Mr Schröder's Social Democrats by some 10 percentage points.
An opinion poll conducted after polling last night concluded that 71 per cent of German voters were confused about Ms Merkel's controversial plans to raise VAT and plans by Paul Kirchhof, her "tax guru", to introduce an eventual 25 per cent flat tax. Most polled agreed with the criticism: "We don't know where we are with the CDU tax plan."
Mr Schröder had campainged vigorously against the proposals, claiming they were "socially unjust" and meant that "nurses and night shift workers" would end up funding "millionaires' tax breaks".
Yesterday's result was nevertheless a decision by German voters to punish Mr Schröder for failing to live up to his 1998 election pledge to halve the country's then 3.5 million unemployed.
During his seven years as Chancellor, Germany's jobless rate has spiralled to 5 million, the highest level since the country's pre-Nazi Weimar era of the early 1930s. Current statistics show that an estimated 1,000 jobs are lost in Germany each day, while 4,000 companies declare insolvency each year.
Mr Schröder's decision to call an early election, one year ahead of schedule, followed a series of humiliating defeats for his ruling Social Democrats in regional state elections over the past two years.
His party's run of electoral disasters culminated in North Rhine Westphalia, Germany's most populous state, in May this year, when the SPD was defeated by Ms Merkel's conservative Christian Democrats for the first time in 39 years. The defeat, like all the others, was a vote of no-confidence in Mr Schröder's hugely unpopular Agenda 2010 programme which aimed to kick-start Germany's ailing economy.Reuse content