Published: Monday, 28 Sep 2009 | 2:43 AM ET

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German Chancellor Angela Merkel's conservatives vowed on Monday to seal a coalition deal, including tax cuts, with the pro-business Free Democrats (FDP) within a month after Sunday's election victory.

Merkel's conservatives won a parliamentary majority with the FDP, her partner of choice, enabling her to end her awkward four-year-old partnership with the Social Democrats (SPD).

Now the two center-right parties must try to forge compromises on a range of issues including tax, labor market policy and domestic security in Europe's biggest economy.

"Coalition talks should start as soon as possible...and it is our goal to have a coalition deal in a month at the latest," said Ronald Pofalla, General Secretary of Merkel's Christian Democrats (CDU).

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The next government faces major economic challenges. It will have to consolidate a surging budget deficit, cope with rising unemployment and ward off a credit crunch. The stock market looked set to open flat. Pofalla said his party was sticking to its election promise of tax cuts.

"We want tax cuts in two steps in the next legislative period which will result in relief of 15 billion euros ($22.03 billion)," he said.

However, the FDP will push for a more ambitious program. While Merkel has steadfastly refused to put a timeframe on her party's plans, given the dire state of public finances, the FDP campaigned for quick cuts worth 35 billion euros.

The latest results put Merkel's conservative bloc, the CDU and Bavarian Christian Social Union (CSU), on 33.8 percent, their second-worst postwar result, down from 35.2 percent in 2005.

But the FDP offset the losses, surging to 14.6 percent, its best ever score, and putting the center-right ahead.

AP Angela Merkel

The SPD was the biggest loser and will join the Greens and Left party in opposition after plummeting more than 11 points to 23.0 percent, its worst result since World War Two.

Tough Talks

The coalition talks between the parties could be tough, largely because the FDP will be emboldened to make demands after its strong showing.

"Considering the strength of the junior partner, (the ideas) of that party will penetrate negotiations. That includes the simplification of the income tax system as well as tax relief," said Heino Ruland of Ruland Research in a note.

The FDP is also widely expected to push for laws to make it easier for firms to hire and fire. Markets, which had feared another grand coalition would lead to policy gridlock, could take heart from the result, which gives the conservatives and FDP a comfortable majority.

But early indications were that the DAX

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"In capital market terms, we assume that the new coalition is by and large priced in," said Ruland.

He noted that energy suppliers might gain some support due to the potentially longer lifetime of nuclear power plants, as the coalition partners have pledged to reverse a law that would close them by 2020.

Consumer stocks could benefit from possible tax relief. The coalition is also expected to look for opportunities to sell off state holdings in companies like rail operator Deutsche Bahn.

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