Unclear German election outcome kicks euro lower

Though the result meant Angela Merkel secured a fourth term as chancellor, support for her conservatives unexpectedly slumped to its lowest since 1949 and the Social Democrat, partners in the outgoing coalition, said they would go into opposition.

"Markets don’t like uncertainty and the German election results have injected a healthy dose of (that)," said Richard Falkenhall, a strategist at SEB AB in Stockholm.

The euro was trading near the day's lows and down more than half a percent against the dollar and sterling as spreads between peripheral bonds and German debt widened.

The euro has been the best performing major currency this year, having gained more than 13 percent against the dollar.

The news from Germany is likely to refocus investor attention on other political events in Europe, particularly a divisive independence referendum in Catalonia on Oct. 1 and Italian elections next year.

Markets may conclude that the political backdrop in the euro zone remains disjointed and poses a threat to investment potential in the medium term, Rabobank strategists said in a client note.

Fund managers at Schroders said that, given the uncertainty over the formation of a German coalition, achieving deep European reforms looks likely to have become more complex .

The dollar gained against a broad basket of currencies, rising 0.4 percent as investors reduced short bets against it.