Widespread scepticism over Germany's coalition

Under the deal, VAT will rise from 16 per cent to 19 per, one of Ms Merkel's key election pledges. It will also see a new higher income tax on top earners, fulfilling a key demand of the centre-left social democrats. The new rate will probably be 45 per cent rather than the current top rate of 42 per cent.

The President of the country's Employers' Association BDA, Dieter Hundt, told the press: 'This is poison for the economy', adding: 'The new government will make a '100 per cent wrong start.'

Trade union leaders warned that the coalition government's ill-advised fiscal policy would only swell the 4.8 million-strong army of the unemployed, and encourage illegal work by some EUR5bn.

VAT increase

Since the increased VAT will become affective only from 1st January 2007, analysts expect a short flare-up of consumer spending next year. Particularly car, furniture, electronic goods and other consumer durables sales will be up temporarily resulting in a slightly higher growth than originally expected (1.8 to 2.0 per cent instead of 1.0 per cent). However, Stefan Bielmeyer of Deutsche Bank warned: 'From January 2007, the shops will be virtually empty, and the growth will slump.'

The VAT increase is one of a series of austerity measures designed by the coalition to plug the EUR35bn hole in the state budget. Employers gave a cautious welcome to the announcement that Germany's over-protected job market will be loosened slightly.

In future, newly hired workers will not receive legal protection against redundancy for the first two years of the contract, up from the current period of 6 months.There is also a general public acceptance of the decision for a gradual rise of the retirement age to 67 from 65.

Despite the widespread scepticism, most Germans seem to be relieved that the deal at least has ended two months of political crisis and uncertainty in the country.