Sept. 19 (Bloomberg) -- The euro touched a seven-week low against the dollar after Germany's election failed to produce a clear winner, dimming the prospect for lower taxes and labor costs promised by opposition leader Angela Merkel.

Europe's common currency had its biggest slide in a week as Merkel's Christian Democrats won 35.2 percent of the vote and Chancellor Gerhard Schroeder's Social Democrats 34.3 percent, provisional results showed. The right to run the largest economy in Europe was claimed by both Schroeder and Merkel, who lost a 15 percentage point lead in opinion polls during campaigning.

``This outcome is going to be very negative for the euro,'' said Shahab Jalinoos, a currency strategist at ABN Amro Holding NV in London. ``There's no clear picture of who's going to take the lead and therefore it's hard to see how we're going to get economic reform.''

The euro dropped to $1.2147 at 10:07 a.m. in London, from $1.2234 on Sept. 16 in New York, according to electronic currency- dealing system EBS. It reached $1.2101 earlier today, the weakest since July 29. Against the yen, the European currency declined to 135.40, from 136.25. Trading was closed today in Tokyo and Hong Kong for holidays.

`Deeply Disappointing'

Merkel's policies won her support from business groups such as the BDI industry federation, which represents 107,000 of the country's biggest businesses. Among her proposals are suspending legal protection against unfair dismissal for companies with 20 workers or fewer and reducing income and corporate taxes.

German unemployment rose to a post-World War II record of 12 percent in March, while the economy stagnated in the second quarter. In the U.S., the jobless rate fell to 4.9 percent in August, the lowest in four years.

The result is ``deeply disappointing,'' Juergen Thumann, the president of the BDI, told Germany's ARD television. ``It will be more difficult to govern Germany.''

European Central Bank President Jean-Claude Trichet will deliver a speech on the region's economy and the 12-nation currency at 1:30 p.m. London time, in Paris.

Europe's currency pared its losses as some analysts said last week's decline in the euro already reflected concern about Germany's election outcome. The euro last week fell the most in a month against the dollar as opinion polls indicated neither of the main two parties would emerge as an outright victor.

`Likely to Rebound'

``There's a risk we get a bit of an overreaction to this result,'' said Marios Maratheftis, a currency strategist at Standard Chartered Plc in London. ``We could still see reforms happening in Germany and as the result becomes clearer the euro is likely to rebound.''

The 14-day relative strength index for the euro against the dollar today declined to 37.7, the lowest since July 7. The index is a gauge of momentum in a given period, and levels below 30 or above 70 suggest a change in direction.

Futures traders scaled back bets on the euro's advance, according to figures from the Commodity Futures and Trading Commission in Washington released on Sept. 16.

The difference in the number of wagers by hedge funds and other large speculators on an advance in the euro compared with those on a drop -- so-called net longs -- was 7,585 on Sept. 13, versus 23,518 a week earlier.

Betting on `Measured'

The dollar may rise against the yen on speculation the Federal Reserve will raise interest rates tomorrow and signal further increases. Fifty-two percent of the 65 traders, strategists and investors surveyed on Sept. 16 from Sydney to New York advised buying the dollar against the euro.

Traders are betting the Fed will keep its commitment to raise rates at a ``measured'' pace after 10 increases since June 2004. Participants made their forecasts a day after reports from the Fed Banks of Philadelphia and New York showed prices paid by manufacturers surged this month.

All but four of the 22 primary dealers that trade U.S. government securities with the Fed predict policy makers will raise their benchmark rate by a quarter percentage point to 3.75 percent tomorrow, according to a Bloomberg survey. The European Central Bank has kept its rate at 2 percent since 2003.

The yen traded at 111.46 versus the dollar from 111.34 in New York on Sept. 16.

Germany's final election result may not be known for weeks. Voting results left Merkel's Christian Democrats and Schroeder's Social Democrats as the only two parties with enough seats to form a coalition together. The parties have a month to reconcile their differences before the chamber must convene and elect the new chancellor.

``Obviously, the pressure will be on the downside of the currency until we get some degree of clarity on who is going to be Chancellor and what form of government we are going to have in Germany,'' said Callum Henderson, head of global currency strategy in Singapore at Standard Chartered Plc.

The European currency may fall as low as $1.20 in coming week, he said.

The final result of the polls will be given after an Oct. 2 election in Dresden, where voting was delayed after a candidate died.

To contact the reporter on this story: Rodrigo Davies in London rdavies13@bloomberg.net

Last Updated: September 19, 2005 05:20 EDT