FACTBOX-Key political risks to watch in Britain

LONDON, July 1 (Reuters) - Britain's Conservative-Liberal Democrat government unveiled the harshest austerity drive in decades on June 22 to cut a record budget deficit, but executing the plan could put the new coalition partnership under strain.

Markets and credit ratings agencies have indicated the tough tax and spending measures should stop Britain sliding into a Greek-style fiscal crisis, although those bound to feel the pinch -- UK voters -- are likely to be far less impressed.

There are also fears that spending cuts of about 25 percent at government departments and broad tax rises could hold back Britain's fragile economic recovery and drive up unemployment.

Gilts and sterling have rallied since the coalition replaced Labour last month and the budget gave another boost to UK assets, which look a relatively safe bet for the time being unless the economy stalls or the coalition wobbles.

Below are the key political risks to watch.

THE COALITION

The budget spelt the end of the new government's honeymoon period and markets will now be on alert for any sign of cracks in Britain's first coalition since the Second World War.

A worst -- and somewhat unlikely -- outcome would see the Conservative-led coalition fall apart before the end of the year, triggering another election and hampering deficit cuts.

A best outcome for markets would result in the coalition lasting a full five-year term, cutting borrowing swiftly but also in a way that gives the recovering economy room to breathe.

The austerity budget made it through parliament but not without grumbles from some in the smaller, centre-left Lib Dems who said some of the measures would hurt the poor.

Tougher tests await. The government spending review later this year, which will detail where the axe will fall, and legislation for electoral reform could create clearer divisions.

What to watch:

-- Indications of stable government for at least a couple of years. Investors will want to see how the leadership controls dissent, especially over electoral reform and Europe.

-- The ousted Labour party. With former Prime Minister Gordon Brown gone, the party is electing a new leader, with a winner to be announced in September. A revived Labour could wield a big influence on the coalition's survival prospects.

AMBITIOUS DEFICIT REDUCTION

It will be no easy task to deliver on plans to all but eliminate Britain's record budget deficit -- currently around 11 percent of national output -- by the next election in 2015.

The coalition has announced plans to raise VAT sales tax, reform -- or rather cut -- welfare benefits and slash government department spending by around 25 percent.

More detail of where those cuts will come in a four-year spending review on Oct. 20, but some of the budget measures have already ruffled feathers on both sides of the coalition.

Many on the right of the centre-right Conservatives were annoyed by an increase in capital gains tax even though it fell short of the demands of the smaller, centre-left Lib Dems.

The new bank levy -- designed to make banks pay a downpayment for the cost of any future crisis -- also fell short of some earlier estimates.

Those on the left of the Lib Dems will worry the poor and elderly could suffer more from spending cuts and job losses or industrial action in the public sector would also be hard to swallow for the more progressive wing of the coalition.

A further complication is Britain's fragile economy which is only just finding its feet again after an 18-month recession which carved off more than six percent of the economy.

Policymakers say a harsh deficit plan is bound to weigh on growth but that is a better alternative than the damage that could come from a full-blown fiscal crisis.

What to watch:

-- Cracks in the coalition that may appear in the run-up to the spending review. A focus on welfare spending, public sector pay and pensions in the deficit reduction plan could trigger a lot of soul-searching among progressive Liberal Democrats.

-- Signs that Britain's economy is stuttering or reversing into recession. Finance minister George Osborne would come under pressure to explain why he rushed into slashing borrowing at such a swift rate given strong warnings about risks to growth.

THE BANKS

The Bank of England will take over macroprudential regulation of the banks by 2012, with sovereign debt concerns and a continued dearth of credit likely to weigh on the financial sector for the foreseeable future.

The coalition has introduced a 0.07 percent bank levy on balance sheets without complete international approval. The tax will raise far less than had been speculated earlier this year.

What to watch:

-- An interim report on splitting banks is expected within a year. Any swift changes banks' structures are likely to hurt shares in banks such as Barclays (BARC.L) and HSBC (HSBA.L).

-- The sector will also be eager to see how Britain's central bank adapts to its regulatory powers.

EXTERNAL AND INTERNAL STRAINS

Conservative Prime Minister David Cameron has taken over a country at war in Afghanistan, an issue which could become a dividing point within the coalition. The Lib Dems are far less enthusiastic about aggressive foreign policy.

The coalition might also face an upsurge in republican violence in Northern Ireland.

Social and labour unrest is a worry, given the scale of austerity measures facing Britain.

The largely eurosceptic Conservatives and more europhile Lib Dems could fracture over relations with the European Union.

There are also divisions on nuclear power, with the Lib Dems opposed to new nuclear power stations but promising merely to abstain when it comes to a parliamentary vote on the issue. The coalition is at one with Germany on deficit reduction when others such the United States want to see some patience on cuts. The UK has also lined up with France and Germany on introducing bank levies without waiting for G20 approval.

What to watch:

-- Does the EU agree further bailout packages for troubled fringe euro economies? Any worsening in relations with the EU could imperil Lib Dem support for the coalition.

-- Does NATO request more troops for Afghanistan?

For political risks to watch in other countries, please click on [ID:nEMEARISK] (Editing by Sonya Hepinstall)