LONDON Talks to form a new British government entered a decisive phase on Tuesday with speculation the Conservatives were close to clinching a deal with the smaller Liberal Democrats while Labour was being sidelined.
The Conservatives won most seats in a parliamentary election last week but fell short of a majority. Labour, in power for the past 13 years, came second and the Lib Dems a distant third.
Both of the major parties have been trying to win over the Lib Dems, but senior Labour figure Ed Miliband said on Tuesday afternoon the talks between his party and the Lib Dems were "temporarily" over, fuelling speculation they had broken down.
Britain's sterling currency jumped one percent against the dollar and government bonds rallied on a flurry of media reports that it was game over for Labour and a Conservative/Lib Dem deal was imminent.
Negotiators from the two parties had been locked in talks for close to five hours on Tuesday, with expectations growing that they had agreed a deal to form Britain's first coalition government since 1945.
Prime Minister Gordon Brown's office denied a report that he had resigned. Brown was in his Downing Street residence on Tuesday evening awaiting news of the outcome of the talks.
MARKETS WANT CLARITY
Markets want a quick resolution to the uncertainty and favour a Conservative-led government because they believe it would move faster and harder to cut Britain's record budget deficit.
The Lib Dems had turned to the Conservatives first, on the basis that they had won most votes and most seats in last Thursday's election. But Labour's Brown threw a spanner in the works on Monday when he said he would step aside in coming months.
The move was aimed at tempting the Lib Dems away from the Conservatives and into an alliance with Labour. The Lib Dem leader Nick Clegg had made it clear during the campaign he did not wish to prop up the unpopular Brown.
Clegg said earlier the talks had entered a "critical and final phase."
"I am as impatient as anybody else to get on with this, to resolve matters one way or another," he told reporters.
Conservative leader David Cameron, who stands to become prime minister if his party prevails in the tussle for Lib Dem support, said it was "decision time" for the smaller party.
Britain is emerging from its worst recession since World War Two with a record budget deficit that analysts believe will only be cut effectively by a strong and stable government.