Merkel suffers setback months before federal vote

By Noah Barkin

BERLIN (Reuters) - In an extremely tight German state election that seemed to produce few clearcut winners, there was no question who the biggest loser was - Angela Merkel.

Her Christian Democrats (CDU), led by local star David McAllister, had convinced themselves over the past week that they were on the verge of a come-from-behind victory to keep control of Lower Saxony, a vast agricultural and industrial region that resembles a U.S.-style swing state.

But on Sunday, they came up short, losing the state to the center-left Social Democrats (SPD) and Greens, who together won one more seat in the state assembly than the center-right.

In one fell swoop, the result gives the center-left a majority in the Bundesrat upper house of parliament, meaning the opposition can block major legislation from Merkel's government and initiate laws themselves.

It is a bitter defeat for the 58-year-old chancellor, even if she remains popular and a strong favorite to win a third term in a federal election eight months from now.

"I'm not going to pretend. After all the feelings generated by this election, defeat hurts even more," Merkel told a news conference in Berlin, standing alongside a gloomy-looking McAllister. "We are all sad today. Sad that it didn't work out."

The center-left will keep control of the upper house after the national election in September, even if Merkel's center-right coalition with the liberal Free Democrats (FDP) manages to hold onto power.

In the run-up to the vote, Merkel's room for maneuver will be limited, and the notoriously risk-averse German leader may take a more cautious stance on a range of policy issues, including the euro zone debt crisis.