LONDON (Reuters) - British Chancellor George Osborne will press on with a far-reaching overhaul of the banking sector and urge Europe on Thursday to fix its finances to help drag the UK out of its second recession in four years.
In his annual Mansion House policy speech to London's financiers, Osborne is expected to defend his deficit-cutting plans and argue it has created some room for other policy levers to help revive the economy.
The Conservative has rejected calls to abandon his austerity plans and, with the Labour opposition ahead in opinion polls, is now hoping for a strong private-sector-led recovery in time to win back support for the next election in 2015.
Failure to get growth going before then could spell electoral disaster for the centre-right party and its smaller coalition partners, the Liberal Democrats.
The Mansion House speech, a flagship event in British politics, offers Osborne a chance to get on the front foot after a string of public relations blunders over an annual budget that cut income taxes for the wealthy and stung pensioners.
Bank of England Governor Mervyn King will also speak at the event, which has previously exposed faultlines between the central bank and government over economic policy, potentially giving a steer on the future path of monetary policy.
Osborne is unlikely to announce any new policies aimed at engineering a recovery, sources said, but he may lay the ground for an imminent decision on how to use the government's balance sheet to leverage private-sector investment in infrastructure.
"Tighter fiscal policy has opened up the possibility of other policy interventions that wouldn't otherwise have been there for us," said a Treasury source.
"It's about the country being able to afford what it's doing. Having a tighter fiscal policy has enabled that," he said.
Osborne, who earlier this week blamed the euro zone for Britain's recession, is likely again to risk the wrath of his European counterparts by insisting that the single currency zone sorts out its own problems and takes full responsibility for underwriting its banks.
Osborne has made cleaning-up Britain's powerful banks central to his tenure, after the 2008 credit crunch drove several of them to the brink of collapse, and forced the then Labour government to pledge more than a trillion pounds of taxpayer money to shore up the system.
He is expected to broadly implement last year's recommendations from an independent panel - the Independent Commission on Banking - with a few practical concessions for banks with large overseas operations.
A key element of the reform is to ringfence banks' retail banking and business with small- and medium-sized enterprises, to keep them separate from riskier investment banking activities.
Ringfenced banks will be expected to hold a minimum 17 percent capital as protection against losses, but the government is expected to apply this rule only to UK-based lenders.
That could leave the door open for Labour to accuse ministers of watering down the reforms, but banks such as Barclays and HSBC, which did not need bailouts, are likely to argue the plans are more than tough enough.
Britain's economy has struggled to return to health in the wake of the financial crisis, and this year fell back into recession, piling pressure on Osborne to soften his austerity drive and find news ways to boost growth.
He is expected to devote a large chunk of his Mansion House speech to defending his economic approach, retreading the argument that tight fiscal policy gives the Bank leeway to stimulate growth.
The Bank has injected 325 billion pounds of cash into the economy via its purchases of UK government bonds, and held interest rates at a record low 0.5 percent for the last three years, but this month opted against any further easing.
The government believes the central bank still has room to stimulate growth if necessary, and the International Monetary Fund urged it last month to consider cutting rates even further and widen the scope of its asset purchases.
King, who is due to retire next June, has so far staunchly opposed such suggestions, arguing the central bank is ill-placed to take on the credit risk of intervening in the private sector.
Reporting by Fiona Shaikh, editing by Mike Peacock