Germans punished Chancellor Angela Merkel's centre-right coalition in a state election on Sunday, depriving her of a majority in parliament's upper house after she angered many by agreeing to aid Greece.
The loss in the state of North Rhine-Westphalia (NRW) is a blow to Ms Merkel little more than six months into her second term in office and means she will have to rely on opposition parties to deliver her policy agenda, which includes tax cuts.
A result-based projection by ZDF television put Ms Merkel's Christian Democrats (CDU) on 34.3 percent and their Free Democrat (FDP) allies on 6.6 percent, short of a majority and leaving the make-up of NRW's next government unclear.
The Social Democrats (SPD), Germany's main opposition party, polled 34.5 percent of the vote - a whisker ahead of the CDU, the projection showed. Final results are due during the night.
"From an investor's perspective, this is another warning signal to foreign capital that not all is well in Europe," said Andrew Bosomworth, a senior portfolio manager at bond giant PIMCO Europe.
"Strong leadership is needed at a time of crisis and what we're likely to see here is a dilution of leadership. This is not something that will increase faith in the euro," he added.
The election was widely regarded as a referendum on Ms Merkel's government and came just two days after her coalition voted in parliament to release billions of euros in aid to debt-stricken Greece -- a move deeply unpopular with the public.
The outcome leaves Ms Merkel's government weakened at a time when investors are also concerned about political leadership in Britain -- one of Europe's leading economies after Germany -- following an indecisive parliamentary election.
"This is a bitter defeat for the CDU in the state and federally," said Gerd Langguth, political scientist at Bonn University and Ms Merkel biographer.
The CDU lost 10.5 percentage points from the 2005 election and one member, Willy Wimmer, even called on Ms Merkel to resign.
"Resignations are unavoidable to avoid a lingering decline," Mr Wimmer, a former deputy defence minister, told the Leipziger Volkszeitung, which also reported that he called for the "immediate resignation of Angela Merkel."
He did not spell out whether he was referring to her role as chancellor or as CDU party chief.
Opposition parties have attacked Merkel for her handling of the Greece crisis after she initially resisted granting aid due to massive popular opposition to a bailout.
Her vice chancellor, FDP leader Guido Westerwelle, said the state election result was a setback. "This is a warning shot for the (federal) government parties," Westerwelle said.
The CDU and FDP have ruled in NRW since 2005 and their coalition there mirrored a power-sharing deal at national level that they embarked on after last September's federal election, when the Social Democrats slumped to defeat.
"The SPD is back," the party's leader in NRW, Hannelore Kraft, told jubilant supporters after the first exit poll results, adding that she wanted to rule with the Greens.
There are some 13.5 million eligible voters in North Rhine-Westphalia and its economy is roughly the same size as those of Poland and the Czech Republic combined.
The defeat for CDU state premier Juergen Ruettgers may signal a turning in the political tide in Germany, which has been shifting in favour of the CDU for much of the past decade.
The ZDF projection showed the Greens were the big winner, gaining 6.2 percentage points to 12.4 percent and the far-left Left party garnering 5.7 percent of the vote.
The loss of a CDU-FDP majority in NRW means Merkel can no longer bank on the Bundesrat, or upper house, made up of representatives from the states, waving through her policies.
She needs Bundesrat approval for her main policy platform, including tax cuts, health reform and the extension of the lives of some nuclear power plants.
"The loss of the Bundesrat (upper house) majority is not an insurmountable problem for the chancellor but it makes it more complicated for her coalition to get through some important policies," said Langguth.
Reuters