By Andreas Rinke and Joseph Nasr
BERLIN (Reuters) - German Chancellor Angela Merkel's efforts to form a three-way coalition government that would secure her a fourth term hit a major setback on Sunday after a would-be coalition partner pulled out of exploratory talks, citing irreconcilable differences.
The pro-business Free Democrats (FDP) unexpectedly walked out of the talks with Merkel's conservatives and the Greens, saying that the three parties could not find compromises on key issues like immigration and the environment.
Merkel could seek to form a minority government with the Greens, or new elections will be called.
"Today there was no progress but rather there were setbacks because targeted compromises were questioned," FDP leader Christian Lindner told reporters. "It is better not to rule than to rule falsely. Goodbye!"
Merkel was weakened after an election in September as voters angry with her decision in 2015 to open Germany's borders to more than a million asylum seekers punished her conservatives by voting for the Alternative for Germany (AfD) far-right party.
There is little appetite for a second vote, especially as the main parties fear that the populist AfD would win more than the almost 13 percent of votes it secured in September.
Failure to form a government in Europe's largest economy could have implications for everything from euro zone reforms to European Union policy on Russia and Turkey.
Merkel has used her power to broker compromises on Greece within the single currency bloc and to keep in place EU sanctions against Russia over its backing of separatists in eastern Ukraine.
(Reporting by Andreas Rinke and Joseph Nasr; Writing by Joseph Nasr; Editing by Peter Cooney)