* Merkel eyes coalition with Free Democrats after Sept vote
* Has common ground with SPD on climate, financial reform
* Centre-right govt could quarrel on range of issues
By Noah Barkin
BERLIN, Aug 24 (Reuters) - Chancellor Angela Merkel could find it more difficult to deliver on key elements of her policy agenda if she wins a second term next month and ends up forming the centre-right "dream coalition" that eluded her in 2005.
Germany's Free Democrats (FDP), who favour small government and free markets, are Merkel's partner of choice in a campaign that pits her against the Social Democrats (SPD), the party with which she has ruled for the past four years.
That is because the FDP more closely mirrors the views of Merkel and her Christian Democrats (CDU) on a range of economic issues at a time of global crisis, from privatisations to taxes and industrial policy.
But people close to the chancellor acknowledge that after pulling her party to the left during her first term, she now has more in common with the SPD on a host of other key issues, including climate change, financial market reform, domestic security, family policy and the future of carmaker Opel.
That has left her more pragmatic than is commonly assumed about the merits of the two most likely post-election constellations -- a CDU partnership with the FDP or SPD.
"She wants a coalition with the FDP because she believes the big challenge in the next legislative period will be to deal with the impact of the crisis and on economic policy there is simply more common ground," said one official close to Merkel.
"But she knows the climate will not necessarily be better with the FDP and expects them to push aggressively for what they want. She is under no illusions that it would get easier, nicer or more harmonious," the official added, requesting anonymity.
Even on the economy, there is potential for conflict. Like the FDP, Merkel has promised to pursue tax relief, but on a far smaller scale than her preferred partners want.
And she no longer advocates making it easier for firms to lay off workers, a step the FDP is demanding.
ACHIEVEMENTS STAND OUT
When Merkel's conservatives scraped by the SPD in the 2005 election and were forced into Germany's first right-left coalition since the 1960s, the assumption was that it would be a recipe for infighting and gridlock.
But after four years, it is the coalition's achievements that stand out more than its failures, especially when measured against the low expectations that greeted it.
Merkel and the SPD pushed through an increase in the retirement age to 67 and came close to balancing the federal budget before the crisis hit and sent the deficit soaring.
Perhaps the coalition's biggest accomplishment has been its handling of the crisis itself.
Merkel and her cabinet were slow to recognise its seriousness for Germany, but once this sunk in, her coalition pushed through two successive stimulus packages worth a total of 81 billion euros ($116 billion) in the span of a few months.
Criticised by Berlin's allies as too little at the time, the growth programmes have helped pull Europe's largest economy out of its worst recession since World War Two. Some elements of the stimulus, like a car-scrapping subsidy, have since been adopted by Germany's partners.
One reason for the legislative achievements of the "grand coalition" has been its dominating majority within Germany's lower house of parliament.
This allowed it to push through laws with little opposition, an advantage that would probably disappear if Merkel were to team up with the FDP -- a pairing that would yield a confrontational left-leaning opposition composed of the SPD, Greens and the Left party, a far-left grouping.
BIG DIFFERENCES
Many within the CDU fear Merkel's coalition with the SPD has outlived its usefulness, having already tackled many of the issues where compromise was possible.
Amid the common ground, big differences remain between the parties on nuclear power, Turkey's EU bid and reform of Germany's costly healthcare system -- an area where the parties produced a messy compromise that the CDU would like to revisit.
Merkel would find it easier to overhaul Germany's complex tax system, a key priority that dates back to her 2005 campaign, if she dropped the SPD in favour of the FDP.
Still, Gerd Langguth, a political scientist at Bonn University who has written books about Merkel, says the common assumption that Merkel would see another "grand coalition" as a major setback is wrong.
"Merkel is pragmatic, she is an unideological problem solver and could live very well with another grand coalition," he said.
Langguth notes that over the past four years, she has forged close relationships with some of her SPD cabinet colleagues.
Days before the Sept. 27 election, she will travel to Pittsburgh for a G20 summit in the same plane as SPD Finance Minister Peer Steinbrueck, on whom she has relied heavily during the crisis.
With an FDP colleague in this key post and Karl-Theodor zu Guttenberg, the rising star of the Christian Social Union (CSU), wielding more influence in a new cabinet, Merkel could feel huge pressure from her right flank, says Wolfgang Nowak, head of the Alfred Herrhausen Society, a Deutsche Bank think tank.
After witnessing fierce policy clashes between the CDU and FDP as a member of former Chancellor Helmut Kohl's cabinet in the 1990s, Merkel now jokes in private that the coalition fights of the past four years could pale in comparison to those she would face if she wins and ends up with her partner of choice.