ATHENS (Reuters) - Greece's conservatives are close to forming a new coalition government following a narrow election victory, a party official said on Monday, after their leader promised to soften the country's punishing austerity program despite German opposition.
A relief rally on financial markets after Sunday's vote quickly fizzled out as it became clear that the New Democracy party of Antonis Samaras had failed to win a strong mandate to implement the big spending cuts and tax increases demanded by the European Union and the IMF under a bailout deal.
Radical left-wing bloc SYRIZA and smaller parties opposed to the conditions attached to the 130 billion euro ($164 billion) bailout won around half the vote, though they took fewer seats in parliament because the electoral system rewards the first placed party disproportionately.
Samaras received a mandate from the president to form a coalition, and a New Democracy source said the party expected to clinch a deal on Tuesday after Samaras met the third-placed PASOK Socialists and the small Democratic Left group.
Samaras said Greece would meet its commitments under the bailout which aims to save the country from bankruptcy and an exit from the euro zone. But he added:
"We will simultaneously have to make some necessary amendments to the bailout agreement, in order to relieve the people of crippling unemployment and huge hardships."
A senior New Democracy official expected agreement soon on a new cabinet. "We are going to clinch a deal tomorrow, we will form a government," said the official, who declined to be named.
It would aim to accelerate and broaden a privatization program to top up state coffers, but also ask its creditors to spread 11.7 billion euros of further austerity cuts over four years instead of two.
PASOK would also hold cabinet posts, meaning the two parties which have dominated Greece for decades and led it into crisis would stay in power despite SYRIZA's strong showing. The official also expressed hope that the Democratic Left, a small, moderate leftist party, would also take part.
There were mixed signals from Europe over the extent of any possible changes to the bailout deal. Euro zone paymaster Germany, already irritated at what it sees as the slow pace of Greek reform, ruled out more than minor delays to some targets in the rescue package - Greece's second since 2010.
Chancellor Angela Merkel said at a meeting of G20 leaders in Mexico that any loosening of Greece's agreed reform promises would be unacceptable. "The new government will and must stick to the commitments, which the country has agreed on," she said.
With an emboldened SYRIZA bloc led by charismatic former communist Alexis Tsipras, 37, at the head of a powerful opposition, the new government could face protests soon after taking office unless it can calm social tensions.
Samaras, who voted against the first bailout because it was too harsh, also met Tsipras, who ruled out joining the government. SYRIZA almost doubled its share of the vote since a previous election on May 6, which produced stalemate and propelled Tsipras from fringe obscurity.
SYRIZA supporters celebrated Sunday's result, saying it was a matter of time before the leftists came to power.
With Greece in its fifth year of recession, protests have regularly choked central Athens, some hospitals are running short of medicines, thousands of businesses have closed and beggars and rough sleepers are multiplying.
PASOK leader Evangelos Venizelos, who has seen his once-mighty party's standing collapse due to voters' anger with the ruling elite, said negotiations "must be wrapped up" on Tuesday.
The New Democracy source told Reuters that PASOK would join the government, rather than just vote with it in parliament. "They will participate actively, more than symbolically, and for a long time," said the official.
Democratic Left leader Fotis Kouvelis said he was ready to support Samaras, depending "on the content of what is agreed". Kouvelis has also called for the bailout terms to be eased.
German Foreign Minister Guido Westerwelle said the substance of the bailout agreement was "not negotiable", but that creditors might be willing to offer some flexibility on timing for some of the targets, given the time lost in campaigning.
"We're ready to talk about the time frame as we can't ignore the lost weeks, and we don't want people to suffer because of that," he told German radio on Monday.
The head of the Eurogroup of euro zone finance ministers, Jean-Claude Juncker, said they may agree to some concessions on the austerity measures but they would not be substantially altered. "It would send the wrong signal if we made concessions without good reason," he told German ZDF television.
Inspectors from the "Troika" which represents Greece's lenders - the IMF, European Commission and European Central Bank - are expected to visit Athens once a new government is formed.
A coalition that won only 40 percent of the vote is likely to struggle to push through reforms as the Greek public resents the repeated tax hikes on top of pay and pension cuts.
New Democracy won 29.7 percent of the vote, ahead of SYRIZA on 27 percent and PASOK on 12.3 percent. With New Democracy's 50-seat bonus for coming first, a New Democracy-PASOK alliance would have 162 seats in the 300-seat parliament. Adding the Democratic Left would give it 179 seats.
Analysts were pessimistic. "The crisis has been postponed, not necessarily averted," said Theodore Couloumbis of the Athens-based think-tank ELIAMEP. "For this government to last it has to show results. You can't continue with 50 percent youth unemployment and a fifth straight year of recession."
Markets were also skeptical. The FTSEurofirst 300 index rose 1.1 percent at the open but shed all those gains before two hours were up, as the underlying problems in the euro zone brought investors back to earth. The euro's rise also evaporated.
More worryingly, Italian and Spanish borrowing costs rose strongly with yields on Spain's 10-year bonds at dangerously high levels of over 7 percent and equivalent Italian debt over 6 percent, showing that the euro zone crisis was intensifying.
"The new government must deliver a positive development soon - an easing of the bailout terms or a positive sign in the economy - or people will lose trust in a week," a senior New Democracy official said on condition of anonymity. ($1 = 0.7921 euros)
Additional reporting by George Georgiopolous, Dina Kyriakidou, Karolina Tagaris, Greg Roumeliotis, Harry Papachristou and Deepa Babington in Athens, Gernot Heller in Los Cabos, Mexico, Annika Breidthardt in Berlin, writing by Matt Robinson; editing by David Stamp