The latest round of coalition talks, which picked up from last week's unsuccessful discussions, were widely seen as a test of conservative Merkel's resolve to resist a shift to the left by her Social Democrat (SPD) partners.
While agreeing to SPD chief Kurt Beck's proposal to extend the time period during which older people receive jobless benefits, she resisted other key demands, prompting a sharp reaction from leading SPD politicians after the six-hour talks.
Beck, SPD parliamentary leader Peter Struck and Vice Chancellor Franz Muentefering all criticised Merkel and her conservatives for failing to compromise on postal wages.
''The reluctance of the Chancellor in this matter is highly unfortunate,'' said Struck, accusing her of breaking promises.
Muentefering told German radio that wrangling between Merkel's Christian Democrats (CDU) and its sister party, the Bavarian Christian Social Union (CSU), were to blame for the impasse. The CDU is dependent on the CSU for power as the two form a conservative block in parliament.
''It's a policy of appeasing interest groups that I find highly questionable,'' Muentefering told Deutschlandfunk.
Merkel was forced into a coalition with the SPD after her narrow election victory in 2005 and has laboured since then to keep tensions from breaking the government apart.
BAHN SALE UNRESOLVED Areas of agreement included the extension of jobless benefits and a reciprocal deal, pushed by Merkel's conservatives, to slash unemployment insurance premiums for all workers to 3.3 per cent of gross pay from 4.2 per cent at present.
Under the jobless extension compromise, unemployed people of 58 years and older will receive benefits for 24 months, those from 55-57 years will get them for 18 months and 50-54 year olds will be eligible for 15 months of payouts.
The partners had been at odds on how to finance the unemployment measures. In the end they appeared to have agreed to tap about one billion euros in funds from the Federal Labour Office, which is running a surplus.
The parties will have to come back to the issue of selling a minority stake in German national railway Deutsche Bahn. At the SPD's request, they are mulling a plan to create a holding company for passenger, freight and logistics operations in which it would sell a 49 per cent stake. The government would retain ownership of rail infrastructure.
Miserable opinion poll scores, looming state elections and the challenge of the new far-left Left party have prompted SPD chief Beck to chart a new left-leaning course that has fuelled tension in the coalition.
Merkel has vowed not to reverse economic reforms and insists that cutting unemployment, supporting economic growth and maintaining solid public finances are her priorities.
REUTERS SKB RAI1500