Conservative Angela Merkel will become Germany's first woman chancellor under a deal agreed yesterday that forces Gerhard Schroeder out of power but gives his party great influence over the pace of economic reform.
The coalition deal breaks a political deadlock that has gripped the country since Germans gave Ms Merkel's Conservatives a narrow victory in a September 18 election but too few votes to form a government with her reform-minded liberal allies.
Ms Merkel, a strong advocate of shaking up the German economy with reforms of the labour market and tax system, will take the reins of a government loaded with Social Democrat (SPD) rivals that oppose her policies and will be keen to curtail her plans.
As part of the agreement, the SPD secured many top portfolios, including the foreign, finance, justice and labour ministries, party officials told Reuters.
Ms Merkel's Christian Democrats (CDU) and their Christian Social Union (CSU) allies were left with the economy, interior and defence portfolios. Apart from CSU chief Edmund Stoiber, who is taking over as economy and technology minister, the names of the ministers will not become known for days or weeks.
"There's no doubt we will see a watering down of Merkel's programme," said Katinka Barysch, chief economist at the London-based Centre for European Reform. "When you look at the breakdown of the Cabinet, it is clear that she will need a lot of skills to keep this government together."
The deal sets the stage for Germany's second "grand coalition" since World War II - a grouping which some experts fear could collapse after a few years and increase the voice of smaller fringe parties.
German media have likened Ms Merkel to former British Prime Minister Margaret Thatcher, calling her the "Iron Maedchen" and "Maggie Merkel".
"I am happy but I know that a lot of hard work lies ahead of us," a content but restrained Merkel, told reporters.
The rival parties will begin talks on Monday and hope to finalise the shape of a new government by November 12, said Ms Merkel, 51, who grew up in the former communist east.
Mr Schroeder, 61, who had initially refused to relinquish his hold on the chancellery, will take part in those talks, although he is not expected to play a role in the new government.
He did not appear publicly yesterday, but was seen rubbing his eyes and looking out the windows of the Chancellery, which he will leave after seven years in power.
SPD chief Franz Muentefering said his party had struck a good deal, but could not hide disappointment at having to ditch Mr Schroeder and join a government under Ms Merkel.
When asked what qualified Ms Merkel to succeed Mr Schroeder, he replied: "She is head of the CDU/CSU. That is for them to explain."
Ms Merkel has argued an easing of firing rules and a cut in payroll costs were necessary to ease unemployment and boost the German economy, which has one of the weakest growth rates in the 25-nation European Union.
But signs were already emerging yesterday that Ms Merkel had agreed to water down her policies to secure the top post.
SPD sources told Reuters that unions would retain the right to negotiate sector-wide wage deals under a new government - a right Ms Merkel opposes. It was also unclear if the SPD would back her idea to lift sales tax to pay for a cut in payroll costs.
"Merkel is going to be the chancellor," said Lionel Oster, head of European government bonds at F&C Asset Management. "the fear we have is that she might have given up too much" in order to secure the job.
The euro currency and German stocks wiped out initial gains and German bonds rose yesterday as investors worried a grand coalition might not be able to make headway on reforms.
In foreign policy, where the differences are more subtle, analysts said the SPD was likely to have less influence, even if it did put its own candidate in the Foreign Ministry.
The parties differ on Turkey. The SPD under Mr Schroeder has backed Ankara's bid to join the EU, while the CDU favours a "privileged partnership" that stops short of full membership.