By Padraic Halpin
DUBLIN (Reuters) - Five weeks of largely ineffective attempts to form a government in Ireland has left a weak minority administration as the only option to avoid a fresh election, an unstable compromise that could paralyze policy and stoke labor discontent.
Ireland became one of several euro zone countries left with deeply fractured parliaments as voters angry at not benefiting from an economic recovery ousted Prime Minister Enda Kenny's coalition on Feb. 26 without opting for a clear alternative.
Ireland's central bank said last week that the impasse has so far had little effect on the European Union's fastest growing economy but warned that more protracted uncertainty could have adverse consequences for economic growth.
"We are likely to enter a period of effective political paralysis," said Philip O'Sullivan, chief economist at Investec Ireland, who expects that the government will fail to pass a budget in October, triggering another election.
"We think that the government will struggle to effect meaningful policy actions to address the problems in housing and aspects of public investment, with unhelpful implications for competitiveness."
Kenny's Fine Gael remains the biggest party and is trying to win support from independent lawmakers before asking the country's second-largest party and historic rival, Fianna Fail, to back it from the opposition benches on a vote-by-vote basis.
Investors are confident of no radical policy shifts under a compromise between the center-right parties. The economy is also forecast to beat the rest of the EU for a third successive year and Ireland issued its first 100-year bond at a yield of just 2.35 percent last week despite the political foot-dragging.
However there are major problems to tackle that threaten to choke the recovery.
Eight years after Ireland was left with a surplus of houses following a 2008 property crash, a decimated construction sector has since failed to build even half the 25,000 homes needed each year to meet demand, sending rents in Dublin back above peaks and wiping out the gains of the recovery for many.
The cost and scarcity of housing, especially in cities, threaten to damage investment among multinational firms that employ almost one in 10 people and analysts say the government must do more to cut the cost of building and revive activity.
Pressure is also building on services and infrastructure starved of funding during the crisis, particularly as population growth also outpaces the rest of the EU at a time when capital spending is the second-lowest among the 28 members.
The country's struggling health service has been problematic long before demographic pressures added to its woes, while six years of almost unbroken industrial peace is quickly fraying, as a recovering economy breeds contested wage demands.
EFFECTIVE POLITICAL PARALYSIS
However analysts predict a minority government will do well to last two years and may not see the year out, severely hampering its ability to implement reforms.
"I don't think Fianna Fail will want this to last that long, by this time next year they will likely find an issue to pull the government down on and things like opinion polls will have a major impact and be quite destabilizing in the meantime," said Eoin O'Malley, politics lecturer at Dublin City University.
That would spell the end of a series of lasting coalitions that have served Ireland well in the eyes of investors with the most recent five years of stability credited with buttressing tough reforms demanded in a three-year international bailout.
The minority administration envisaged - which may well be a glimpse of the future after no one party managed to secure even a third of the seats last time out - is proving difficult before it even begins amid a deep mistrust between the main parties.
Both will propose their leader for prime minister for a second time on Wednesday with little hope of success, triggering talks between the two for the first time.
"You can't have a government that might collapse in three months of six months, you can get nothing done," acting health minister Leo Varadkar said last month.
"The civil service pull back from you, vested interest wait you out and you need to do things that may be unpopular so any government has to be stable. You can't do things with the electoral Sword of Damocles is over your head."
(Editing by Alison Williams)