By Sarah Marsh and Thomas Escritt
BERLIN (Reuters) -The far right's first victory in a German state election in the post-war era prompted soul-searching in Berlin on Monday, but Chancellor Olaf Scholz's battered and unloved coalition looked as if it would hold together.
All three parties in Scholz's centre-left coalition suffered painful losses while the nationalist Alternative for Germany (AfD) and a new anti-establishment populist party booked record gains in the eastern states of Thuringia and Saxony on Sunday.
Scholz, a Social Democrat, described the results as "bitter" but Finance Minister Christian Lindner rejected suggestions that his neoliberal Free Democrats (FDP), who fared the worst of all coalition partners, should quit the government.
With a year to go to national elections, the results are nonetheless likely to foment tensions in a coalition riven by ideological differences and struggling to deal with the fallout from the Ukraine war including a cost-of-living crisis.
The AfD became the first far-right party to win a state legislature election in Germany since World War Two with its 32.8% showing in Thuringia. And it came a close second, at 30.6%, behind the mainstream conservative Christian Democrats in neighbouring Saxony.
The FDP were crushed, turfed out of the Thuringia parliament and unable to reach the 5% threshold to re-enter the Saxony legislature. At a news conference, Thomas Kemmerich, the FDP's vanquished candidate in Thuringia, said the result showed it was time for the FDP to plough its own path.
"No," said Lindner. "There we don't agree. It's absolutely essential that we give the economy more stimulus," he added, saying the pro-business FDP was needed in government to do that.
The final week of the campaign was overshadowed by the killing, allegedly by an illegal immigrant, of three people in a stabbing attack that lent momentum to the AfD.
In that light, Lindner said the FDP was prepared to countenance changes to Germany's post-war democratic constitution or European law that would help curb immigration.
Analysts warn that the far right's growing clout could damage Europe's largest economy by deterring investors and skilled labour. "It's a bad signal for international investors," said DekaBank strategist Jochim Schallmayer.
The AfD, deemed "right-wing extremist" by security officials in the two eastern German states, will not govern for as long as other parties stick to their pledge to join ranks to keep it out of power.
But a jubilant AfD said it was the government in Berlin that needed to go and insisted that it had a mandate to govern.
"Voters want fresh national elections," said joint party leader Alice Weidel. "Scholz and his coalition partners should pack their bags."
'RUINING GERMANY'S REPUTATION'
Still, the nationalist, anti-migration and Russia-friendly party has enough seats in Thuringia to block decisions requiring a two-thirds majority, such as appointments of judges or top security officials. This "sperrminoritaet" - German for blocking minority - would give it unprecedented clout in opposition.
"The results for the AfD in Saxony and Thuringia are worrying," Scholz said in a statement to Reuters made in his capacity as a member of parliament for his centre-left Social Democrats (SPD).
"Our country cannot and must not get used to this. The AfD is damaging Germany. It is weakening the economy, dividing society and ruining our country's reputation."
A populist leftist newcomer, the Sahra Wagenknecht Alliance (BSW), founded by a former member of the old East German Communist Party, did better than all of three Berlin coalition partners in its first state elections, coming in third place.
That makes the former Communist a likely kingmaker, but Wagenknecht was cagey on how she would leverage that position.
She told a news conference that any coalition partner would have to acknowledge her party's demand for more diplomacy to end the war in Ukraine and opposition to stationing U.S. missiles in Germany.
"Half the people in Germany are scared of being drawn into a big war," she said of her demand that Ukraine stop receiving German weapons to defend itself against Russia's invasion.
"Two thirds of easterners oppose U.S. missiles," she added - remarks that seemed to reflect Kremlin talking points.