German Chancellor Angela Merkel has held preliminary talks with the Social Democrats (SPD) to discuss the scope for compromises to form a "grand coalition".

Ms Merkel's Christian Democrats and the SPD agreed to a second round of talks after today's three-hour meeting.

Her party emerged as the dominant party from last month's elections, but needs a coalition partner.

The SPD is seen as the likely partner, but has expressed reservations after its support crumbled during the 2005-2009 grand coalition.

Today is the first day of what could be complicated negotiations, which could drag on into next year.

Germany's European partners are watching the coalition manoeuvring in Berlin closely.

Ms Merkel will also hold preliminary talks with the Greens next week.

There is concern that delays could push back EU-wide decisions on important financial crisis-fighting measures, such as the ambitious banking union project.

"Europe is watching us, the world is watching us," Ms Merkel said at an event in Stuttgart ahead of the negotiations.

"We have the common responsibility to build a stable government."

She said the landslide victory of her conservatives in the 22 September election had underscored voters' trust in them.

"Now I will obviously try to justify this trust by fair talks."

The announcement that a second round of exploratory talks would take place with the SPD was seen as an indication that there may be enough common ground between Germany's two main parties for formal coalition talks.

Once the preliminary discussions are completed, a group of 200 senior SPD officials from across Germany must agree before the party enters more formal coalition negotiations with Ms Merkel's conservatives.

"It is still an open question as to whether or not it will come to formal coalition talks," said Andrea Nahles, general secretary of the SPD, striking a firm negotiating stance.

Ms Nahles has said it could take until December or January for a government in Europe's largest and most powerful economy to be formed.