Germany faces the prospect of economic stagnation and the job of repairing his country's "poisoned" relations with the US after Chancellor Gerhard Schroeder won last night?s election with a reduced majority that narrowed his scope to implement painful reforms.
Mr Schroeder said he would immediately start talks with the environmentalist Greens to resume the coalition that has ruled Germany for the past four years, as share prices across Europe fell amid disappointment about the election outcome.
After making criticism of the United States and its threat to attack Iraq a plank of his campaign, Mr Schroeder made a first step towards mending fences by announcing the resignation of a minister who had been quoted as likening the methods of US President George W. Bush to Hitler's.
The US Defence Secretary Mr Donald Rumsfeld had criticised the way Mr Schroeder's re-election campaign was fought, saying it had poisoned relations between Washington and Berlin.
The controversy had distracted voters from Mr Schroeder's failure significantly to cut Germany's four million unemployed.
But with his majority halved, analysts said there was little sense that Mr Schroeder would now be able to overhaul the world's third largest economy, which many economists say is highly taxed, over-regulated and risks becoming as stagnant as Japan's.
His centre-left Social Democrats and the Greens got a majority of just nine over the combined opposition, down from 21, in one of the narrowest votes in post-war history.
SPD officials said they expected to strike a new coalition deal in the next three weeks, and that its first task would be to drive forward planned labour market reforms.
"We can't afford to take any time off," said Mr Schroeder, who dramatically overhauled his conservative rival Mr Edmund Stoiber in the last weeks of the race.
But he faces an upper house of parliament, the Bundesrat, dominated by opposition parties intent on thwarting the government that narrowly robbed them of victory. He also faces powerful vested interests in the trade unions and industry lobby groups, and has been elected by a population used to prosperity and unwilling to stomach radical reform.
"The country remains ungovernable because it is impossible to tackle its economic problems," said Mr Karl-Heinz Nassmacher, political scientist at Oldenburg University. "What we need is a German Margaret Thatcher, but where are we going to find her?"