Gordon Brown will step down to try and keep Labour in power

Britain's prime minister Gordon Brown said on Monday that he would step down this year, sacrificing himself to give his Labour Party a chance of forming a government with the smaller Liberal Democrats.

The Lib Dems are already being courted by the Conservatives, who won most seats in the general election last week but fell short of a majority.

The Conservatives shot back after Brown's statement with their own "final offer" to the Lib Dems, an invitation to include them in a formal coalition and the promise of a referendum on a limited reform of the voting system.

Labour, in power since 1997, came second in the election and the Liberal Democrats, led by Nick Clegg, a distant third. It is the first time since 1974 that a British election has put no party in overall control.

In a solemn statement in front of the official prime ministerial residence at 10 Downing Street, Brown said the Lib Dems now wanted to talk to Labour in parallel to their continuing negotiations with the Conservatives.

"I have no desire to stay in my position longer than is needed," Brown said.

"As leader of my party I must accept that that [the election result] is a judgment on me. I therefore intend to ask the Labour Party to set in train the processes needed for its own leadership election," he said.

Brown's announcement could make it easier for Labour to lure the Lib Dems away from the Conservatives, since Clegg had signalled strongly during the election campaign that he did not wish to keep the unpopular Brown, 59, in office.

Brown did not give a precise time frame for his departure but said he hoped a new Labour leader would be in place by the time of the annual party conference at the end of September.

Britain's currency, the pound sterling, fell and government bonds plunged after Brown's comments. Markets had been hoping for a quick deal between the Conservatives and Lib Dems and will not relish the prospect of further delays as parallel talks take place between the Lib Dems and Labour.

As the bidding war between the two major parties for Lib Dem support intensified, Conservative negotiator George Osborne announced that his party had made a "final offer" to Clegg.

"In good faith, we are making an offer to the Liberal Democrats on a strong, stable government with a considerable parliamentary majority, in coalition, and a referendum on the alternative voting system," Osborne told reporters.

The Lib Dems want a change to a proportional voting system instead of the current first-past-the-post one, which they say is biased in favour of the two big parties and leaves them under-represented in parliament and with no chance of winning office.

The alternative voting system mentioned by Osborne falls short of the Lib Dem demand. In essence, it would mean members of parliament could no longer be elected with less than 50% of the votes in their constituencies, but it would not in itself be a more proportional system.

Speaking after Brown's announcement but before Osborne's comments, Clegg said Brown's decision to throw in the towel "is an important element which could help ensure a smooth transition to the stable government that everyone deserves".

Clegg called negotiations with the Conservatives "very constructive" but said that in the absence of an agreement, it was in the national interest for the Lib Dems to talk to Labour as well, in parallel with the talks with the Conservatives.

Either choice is fraught with difficulties for Clegg. The election gave the Conservatives a more convincing mandate than Labour''s, but the Lib Dems and the Conservatives are far apart on many key issues.

On the other hand, keeping Labour in power after its poor election result would be awkward for the Lib Dems. Even combined, the two parties would still fall short of a majority and would require support from small nationalist parties.

"This twist is disappointing for markets which want a quick resolution to this uncertainty," said David Owen, chief European financial economist at Jefferies Securities and Investment Banking Group.

"Markets were keener on the idea of a Tory [Conservative] government with Lib Dem support, largely because there is a perception they would cut the deficit sooner."

Britain's budget deficit is running at over 11% of national output, raising fears that the country could lose its top-notch credit rating and get into debt difficulties. The markets want to see quick and aggressive action on the deficit.