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The CDU gained 225 seats, while the SDP won 222. The remainder were divided between the Free Democrats (61), the Greens (51) and the new post-communist Left Party (54) with one by-election, in Dresden, yet to be held.

The CDU, which had hoped to form a two-party government with the pro-business Free Democrats, is now attempting to court the Greens in what has been dubbed the 'Jamaica coalition' - so named because of its mixture of green, yellow (FDU) and black (CDU) party colours match the nation's flag.

The Greens, who have been coalition partners in Government with the SPD for the past seven years, have said they will not swap sides to prop up a working parliament even if Frau Merkel sacrifices plans build more nuclear power plants. It is also unlikely that the FDU would accept the Green's Joschka Fischer staying on as foreign minister.

The SPD, meanwhile, is attempting to persuade the Greens and the FDU to join its 'traffic light' coalition of red, yellow and green. This appears unlikely and Andreas Pinkwart, the FDP deputy leader, has said the party would not work with Herr Schroeder but is under pressure to reconsider.

Herr Schröder's final option is to approach the president and suggest that he remains as Chancellor in a grand coalition. Critics describe such an alignment — tried only once before, in 1966 — as a recipe for gridlock.

If, on October 18, the new parliament cannot elect a chancellor in three attempts, the President could appoint a minority government led by the candidate, likely Frau Merkel, with a simple majority or call for new elections.

Roger Boyes, Germany correspondent of The Times, said that if the entrenched party leaders were unable to agree, they may be consigning themselves to political history.

He said: "It may be that Frau Merkel and Herr Schröder become the obstacle to the grand coalition, and that the parties decide the only way to move forward is to get rid of them.

"Such a result would usher in a new era, with new names coming in to replace those people who were considered fixed points in German politics. That would clear the way for the reforms that are urgently required."

Business leaders said that the political limbo, the result of a gamble by Herr Schröder to dissolve parliament a year early which backfired in spectacular fashion, is the worst possible for a country struggling with unemployment and relative economic decline. Some believe that a recession is now inevitable.

"This is exactly what the country didn't need," said a spokesman for car makers BMW.

Bild, the mass-market tabloid, summed up the chaos with the headline: "Merkel's bitter victory" - changing in later editions for "The War of the Chancellors".

The results were a huge disappointment for Frau Merkel, who began as favourite but fought a lacklustre campaign. She was visibly downcast when she faced her supporters.

Herr Schröder, who had seemed to be heading for a crushing defeat just a few weeks ago, claimed that his barnstorming campaign had achieved what had seemed "completely impossible". Raising his arms above his head like a Formula 1 champion, he called the result, from a turnout of 77.7 per cent, a personal defeat for Frau Merkel.

The results also came as a blow to those such as Tony Blair who were hoping that a convincing victory for Frau Merkel would reshape Europe and reinvigorate the Continent’s largest economy.

The other surprise of the night was the strength of Oskar Lafontaine’s fledgling Left Party, a group of disaffected Social Democrats and former East German communists. Without it, Herr Schröder would almost certainly have won another term

The result was greeted with similar headlines across much of Europe, with newspapers across the Continent agreeing that it spelled 'chaos', 'confusion', 'paralysis' and 'a mess'. It does, however, appear to reflect closely the public mood, which accepts the need for reform but is divided on how far it should go.

In France, the conservative Le Figaro warned that aftershocks from Germany's political 'earthquake' would be felt across the EU: "European politics, already derailed by France’s referendum ’no’ (on the draft EU constitution), risks becoming even more paralysed than ever. How can German policy carry on, for example, split between the CDU which opposes Turkish membership of the European Union and the SPD which supports it?"

There was relief in Turkey, where commentators believe that Frau Merkel will have to dampen her ideological opposition to its membership in a grand coalition. The daily Sabah was more pragmatic, saying: "Merkel is unlikely to adopt an attitude to block membership negotiations on October 3 because she will be busy with more important issues."

Results from a final seat in the city of Dresden will be decided on October 2, although that is unlikely to tip the balance of power despite Germany's complex blend of first-past-the-post and proportional representation. Voting was delayed there because of the death of a candidate.

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