By Stine Jacobsen and Zoe Robert
REYKJAVIK (Reuters) - Icelanders opted for stability in a general election with anti-establishment Pirate Party falling short of expectations and the junior partner in the outgoing government emerging on top.
With voters still angered by the 2008 financial crisis and the naming of several government figures in an offshore tax haven scandal this year, Icelanders looked to oust the centre-right coalition in its current form.
The biggest group, the Progressive Party, lost more than half its share of the vote in Saturday's election after Prime Minister Sigmundur David Gunnlaugsson resigned following revelations in the "Panama Papers" scandal.
On Sunday, current Prime Minister Sigurdur Ingi Johannsson of the Progressive Party officially resigned, a formality as the government did not get a majority.
The Pirate Party, founded by a group of internet activists, failed to perform as well as opinion polls had indicated. While its share of the vote tripled from the last election in 2013, it came in only third with 15 percent.
Instead, voters appeared to have recognised efforts to stabilise the economy after its 2008 collapse. The centre-right Independence Party, which shared power in the outgoing government, won the largest share of the vote with 29 percent.
No party has won an outright majority, and President Gudni Johannesson has yet to hand the mandate to the party that will be tasked with forming the next government. Party leaders started talks with Johannesson on Sunday.
The Independence Party said it would try to form the next government.
"We have the most support... So I'd say yes," Independence leader and current Finance Minister Bjarni Benediktsson told Reuters when asked whether he considered his party the winner.
He said he would prefer to form a three-party coalition, but declined to say with whom.
Johannsson of the Progressive Party, who will act as prime minister until the next leader is found, told Reuters he would meet the President on Sunday and said it would be "natural" for the President to look to the Independence Party.
In a tight race, the newly-established Vidreisn, or Reform Party, could become kingmaker. The pro-European, liberal party which won around 10 percent of votes in its first election has not yet taken sides.
The Independence Party has been part of every government between 1980 and 2009 and again from 2013, presided over the privatisation of the banks, the financial sector's liberalisation and demise, and eventual the economic recovery.
NO PIRATE SURRENDER
Poet Birgitta Jonsdottir, who leads the Pirate Party said she was happy with the result. "Our internal predictions showed 10 to 15 percent, so this is at the top of the range. We knew that we would never get 30 percent," she said.
"Epic success! There are a lot of coalition possibilities; lots of work ahead," Pirate Party member Smari McCarthy, who will be one of the party's 10 lawmakers, tweeted.
It excluded working with the Independence Party and would work on forming a five-party alliance with the three other opposition parties and newcomer the Reform Party.
The Left-Green Movement, which emerged as the second-biggest party, said it would be willing to work on such an alliance, but the Reform Party was lukewarm to the idea.
Supporters of the broader pirate movement from 15 countries, along with ex-campaign workers for former U.S. presidential candidate Bernie Sanders, had visited Reykjavik to back the Icelandic party, hoping that it would have a shot at forming the next government and deal another blow to mainstream politicians.
The Independence Party has promised to lower taxes and keep the economic recovery on track. Fuelled by a tourism boom, economic growth has recovered since the banking crisis and is expected to hit 4.3 percent this year.
The senior coalition partner in the outgoing government, the Progressive Party, saw its support dive to 11.5 percent.
It was hurt badly when Gunnlaugsson resigned as prime minister in April after documents leaked from a Panamanian law firm linked him to an offshore company that held millions of dollars in debt from failed Icelandic banks.
The Independence Party will hold 21 seats in the 63 member parliament, up two. Representation by the Left-Green Movement rose three to 10 seats, while the Pirate Party has gained seven to 10 seats.