LONDON Britain's Conservatives and Liberal Democrats will hold further talks on Monday to try to stitch together a deal to govern, with markets anxious for an agreement following an inconclusive election.
Britain has been stuck in an unfamiliar political limbo since Thursday when David Cameron's center-right Conservatives emerged as the largest party in the election but fell 20 seats short of an outright majority in the 650-member parliament.
Analysts say markets, preoccupied with efforts to prevent the spread of the Greek financial crisis, will give the politicians only limited breathing space to cut a deal.
They will have taken solace from comments from the Conservatives and centrist Lib Dems, led by Nick Clegg, that tackling a deficit running at over 11 percent of national output would be a central part of any agreement.
"If the markets were less fragile and nervous at the moment, I think they would be very likely to give the parties the benefit of the doubt and more time to sort things out," said Howard Archer, Chief Economist at IHS Global Insight.
"But in their current fragile state, the markets' patience is likely to be limited so there remains a pressing need for some form of an agreement to be reached quickly," he said, adding that the pound, government bonds and shares could otherwise "be in for a very tough time."
The Conservatives have pledged to make a rapid start on cutting spending and want to hold an emergency budget within 50 days of forming a government.
"We are agreed that a central part of any agreement that we make will be economic stability and the reduction of the public deficit," Conservative negotiator William Hague said on Sunday after close to seven hours of talks with a team of Lib Dems.
Prime Minister Gordon Brown's Labour party, in power since 1997, has argued that cutting too soon would jeopardize a tentative recovery from the worst recession since World War Two, a view echoed by the Lib Dems during the election campaign.
BROWN LOOKS ON
Brown is effectively cast in the role of caretaker prime minister following Britain's first inconclusive election since 1974.
He has said that he will await the outcome of talks between the Conservatives and Lib Dems before seeing whether Labour and the Lib Dems can form any kind of alliance. Even then, their combined seat tally would fall short of a parliamentary majority.
A Lib Dem demand for fundamental reform of a voting system that favors the two larger parties is likely to be a major stumbling block in talks with the Conservatives.
Cameron has offered to set up a parliamentary inquiry into electoral reform but it is not clear if that will be sufficient to satisfy the Lib Dems.
It is also unclear whether a partnership between the Conservatives and Lib Dems would take the form of a coalition or a more limited agreement by the Lib Dems not to obstruct crucial pieces of legislation like the budget.
Brown met Clegg for talks on Sunday afternoon, but relations between the two men are reportedly strained.
Three Labour members of parliament have broken ranks and called on Brown to step aside.
(Editing by Mark Trevelyan)