* New Zealand dollar has bounced back after August slide
* Volatility likely until government make-up is clear
* National government could underpin NZ dollar
WELLINGTON, Sept 24 (Reuters) - The New Zealand dollar is set for more volatility in coming weeks after a general election left New Zealand's major parties with no majority to govern, forcing them to enter negotiations with the nationalist New Zealand First Party.
The ruling National Party secured the largest number of votes in Saturday's election but two of its possible allies lost seats in parliament, making it rely on New Zealand First and its outspoken leader, Winston Peters, to form a coalition.
Labour could also still be in a position to rule, if together with the Green Party, it gets New Zealand First on board. Negotiations are likely to carry on for weeks, with a final tally, including a large number of overseas votes, not due until Oct. 7.
"I wouldn't be surprised to see the Kiwi a little more volatile on this result," Stuart Ive, dealer at OM Financial said on Sunday, referring to New Zealand dollar.
"Clearly when we open on Monday morning we're at the moment no better off it's either going to be Labour or National leading the country."
Last month, the New Zealand dollar fell more than 4 percent against the U.S. dollar to be the worst performer amongst major currencies, and underperformed its Australian counterpart as political jitters and worsening data weighed.
The Kiwi, which was the 11th most traded currency in the world in 2016, has tended to fall when the Labour Party led in the polls due to their "unknown" factor and risen when it showed a lead for National, which has been in power for nearly a decade.
New Zealand has out-performed most of its developed market peers since the global financial crisis, with growth averaging 2.6 percent a year over the past 2.5 years and the government balancing its books.
Critics say much of the growth has come from immigration which has helped fuel a sharp jump in house prices that has in turn widened the gap between rich and poor.
Labour is planning to reduce immigration by up to 30,000 from a record 70,000 a year currently. It also plans to renegotiate certain trade deals to accommodate for a planned ban on foreign ownership of existing homes.
Some economists say those policies would stifle two key sources of New Zealand's robust growth of recent years, although the impact on growth could be somewhat offset by its plan to build 100,000 affordable home over 10 years.
Both National and Labour were expected to maintain a policy of fiscal prudence if they form the next government, with Labour aiming to cut net debt at a slightly slower pace.
But they are likely to differ on monetary policy, with Laour pushing to add employment to the central bank's inflation-targeting mandate which could mean more stimulatory monetary policy, weighing on the Kiwi at first instance.
MARKETS FAVOUR NATIONAL
Nick Tuffley, chief economist at ASB Bank, said markets were likely to put the odds in favor of another National-led coalition given its wide lead over Labour.
"Based off the way the NZD lifted in response to opinion polls that showed swings back to National, the NZD is likely to have a floor under it while the prospects of a National-led government remain," he said.
New Zealand's small stock market has performed strongly, with its benchmark S&P/NZX 50 Index up 13.6 percent year to date. Volatility has increased around the election too, but it remains within striking distance of its August all-time high.
New Zealand First, which has worked under governments led by both parties, said it would not be rushed to decide with which party it would work.
"At this stage we have very little clue as to which way they will go," said Stephen Toplis, head of research at Bank of New Zealand. "With that in mind, I am not sure the market will have anything to come on. If there is anything, I guess it's uncertainty."
(Editing by Lincoln Feast)