Merkel's (CDU) only won to 43 percent of the vote, losing it's absolute majority in the wealthy city-state's parliament, according to projections based on early results.
Responsible was a swing among voters both to the left-wing Social Democrats (SPD), the CDU's coalition partner at national level, as well as to the far-left who were set to fill seats in Hamburg's legislature for the first time. Exit polls showed the SPD increasing their share of the vote to 34 percent from 30.5 percent, while The Left Party looked on course to win 6.6 percent.
"We are the future of Germany," SPD national leader Kurt Beck insisted after the vote. "This election proved that our concerns -- social justice and economic success -- are those of voters."
The Greens -- with whom the CDU has said it is prepared to form a coalition in Hamburg -- won 9.5 percent, down from 12.3 percent, early results showed. It was unclear whether the liberal Free Democrats (FDP) would be able to enter parliament, with the party's share of the vote perilously close to the required five percent.
Nationally the CDU's preferred partner is the FDP, but if the liberals fail to enter parliament, Hamburg's CDU mayor Ole von Beust indicated he was ready to team up with anyone to keep The Left Party out of government.
"We will keep the communists and the left-wing radicals out of government in Hamburg," von Beust vowed.
The result in what was an SPD stronghold until 2004 mirrors that of an election in the western state of Hesse in January which saw the CDU suffer a steep fall in support as voters swung to the left and to the far-left.
The Left Party, a raggle-taggle of former East German communists and SPD defectors, has gained entry to three other western German legislatures in the past year. Its recent success, notably in Hesse, risks redrawing Germany's political landscape.
Widespread unhappiness among low-income sections of society has fuelled the leftward swing, exacerbated this week by shock revelations that rich Germans evaded hundreds of millions of euros in taxes by squirrelling away money in secret trusts in Liechtenstein.
The unfolding tax scandal risks entrenching discontent with the wealth gap between fat cat bosses and workers who feel the government has not allowed them to taste the fruits of the country's economic recovery.
But it is not just the CDU that is in turmoil.
The SPD is split over plans in Hesse to form a regional government with the support of The Left, and party leaders have scrambled to downplay the controversy for fear it could lose votes in Hamburg.
A survey published by Bild am Sonntag tabloid newspaper said SPD supporters were so strongly opposed to a pact with the ex-communists in Hesse that one in four would demand party chief Beck's departure. The SPD's leader in Hamburg, Michael Naumann, on Sunday night promised that he would rather remain in opposition than rule with The Left Party.
"There will be no coalition, no cooperation and no understanding with The Left in Hamburg," he said.
Merkel has exploited the debacle by questioning the integrity of the SPD, while her ultra-conservative ally Erwin Huber warned: "The SPD is playing with fire."
The Left Party is currently trying to live down an embarrassing call by one of its regional MPs in Lower Saxony this month for the feared East German secret police, the Stasi, to be brought back. It has condemned the remark and urged the politician to resign.