German Parties Seal 'grand Coalition'

Germany's two biggest parties agreed a formal coalition deal tonight, allowing Angela Merkel to take over as chancellor nearly two months after the country's general election.

Agreements today on increasing VAT - a key Christian Democrat (CDU) pledge - and upping the top rate of income tax for high earners - part of the Social Democrat (SPD) election manifesto - appeared to be the final pieces of the jigsaw to fall into place, allowing the conservative Ms Merkel to take over on November 22.

"The coalition agreement is completed," Ms Merkel told a news conference. "I'm convinced that the coalition creates a genuine opportunity for Germany."

"It's an ideal coalition agreement" said senior SPD member Wolfgang Thierse, the first politician to officially confirm the deal.

A cabinet of CDU and SPD ministers was agreed last month, after the election on September 18 proved inconclusive.

But the exact detail of an agreed policy platform only emerged today, after several weeks of negotiation.

Tomorrow was the self-imposed deadline for the conclusion of negotiations between the two rival parties. The "grand coalition" of the centre-right and centre-left will be the first time the two parties have shared power since the 1960s.

Under the deal, VAT will rise from 16% to 19% from 2007, 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, although details were not immediately available. Officials had discussed a new rate of 45% rather than the current top rate of 42%.

In her role as chancellor-designate, Ms Merkel spent the day escorting the Chinese president, Hu Jintao, on his visit to Germany.

She will become the country's first female chancellor.

In yesterday's talks the two parties sealed an agreement on foreign policy, putting out a paper stating that the "close relationship of trust between the USA and a self-confident Europe which does not see itself as a counter-weight, but a partner" was "indispensible".

Ms Merkel has already made clear she will distance herself from Mr Schröder's close relationship with Russia's president, Vladimir Putin. The 15-page accord on foreign policy makes special reference to human rights, the rule of law, and specifically mentions Chechnya.

However, possibly to Tony Blair's disappointment, it also rules out renegotiation of EU farm subsidies, stating that "the agreements from the agricultural funding compromise of October 2002 will not be called into question".

Mr Blair had hoped to use his presidency of the EU, which ends in December, to rethink the Common Agricultural Policy, whose budget has been set up until 2014. At a meeting this summer, he offered to renegotiate Britain's £3.2bn rebate, won by Mrs Thatcher, if there was movement on reducing farm subsidies.

Also in yesterday's agreement was a deal to slightly loosen Germany's highly protected job market. In future, new hired workers will not get legal protection against redundancy for the first two years of employment, up from the current position of six months.

The two sides still have to decide on spending cuts to tackle the country's ¿35bn (£23.5bn) budget deficit; and they have to resolve differences over whether to shut down Germany's nuclear power stations - a concession won by the outgoing Greens. They also have to decide on labour and tax policy, with the Social Democrats pushing for a higher income tax for top earners - an idea with which many conservatives are uncomfortable.

Officials have already agreed to several planks for a joint platform, including a gradual raising of the retirement age to 67 from 65.

Mr Schröder, chancellor since 1998, will leave government when he steps down in favour of Ms Merkel. Germany's well-known Green foreign minister, Josckha Fischer, has already said he will return to the backbenches when the new coalition takes over.

Despite starting the election contest with a 19% lead in the opinion polls, Ms Merkel's lacklustre campaign saw the CDU/CSU only take four more seats than the SPD in the Bundestag.

The poor performance scuppered plans to rule in coalition with the economically rightwing Free Liberal party and instead sparked weeks of uncertainty as the parties sounded each other out over potential coalitions.