Sept. 19 (Bloomberg) -- The euro fell to the lowest in more than seven weeks versus 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.

``It's clearly negative for the euro,'' said John Horner, a currency strategist in Sydney at Deutsche Bank AG. ``The reactions of both Merkel and Schroeder post-elections, with neither really conceding much after the vote, suggest it's going to take quite some time for all this to unfold.''

The euro weakened to $1.2115 against the dollar as of 7:06 a.m. in London from $1.2234 on Sept. 16 in New York, according to currency trading system EBS. It fell as low as $1.2110, the weakest since July 29. The euro may drop to $1.20 in coming days, Horner said. Against the yen, it dropped to 135.25 from 136.25.

There may be less currency trading than usual today because Japanese and Hong Kong financial markets are closed for holidays.

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 is suspending legal protection against unfair dismissal for companies with 20 workers or fewer and reducing income as well as corporate taxes.

`Deeply Disappointing'

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.''

Declines in the euro may be limited by speculation some investors have already anticipated power sharing between Germany's two largest parties. The euro last week fell the most in a month against the dollar as opinion polls showed neither side an outright victor.

`Head Higher'

``A lot of negativity over the election was already priced in,'' said Ashley Davies, a currency strategist in Singapore at UBS AG, the world's second-largest foreign-exchange trading bank. The euro ``should head higher this week as uncertainty diminishes and the shape of the new coalition government becomes clearer.''

The European currency will draw demand if it falls to $1.2050 against the dollar, he said.

The 14-day relative strength index for the euro against the dollar today declined to 30.75. 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 111.66 versus the dollar from 111.34 in New York on Sept. 16.

Clarity

The euro also fell on concern Germans may not know for weeks who will head their next government. 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 move between $1.20 and $1.21 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 following the death this month of a candidate.

To contact the reporter on this story: Kosuke Goto in Tokyo at kgoto2@bloomberg.net Rodrigo Davies in London rdavies13@bloomberg.net

Last Updated: September 19, 2005 02:07 EDT