(Reuters) - New Prime Minister David Cameron's Conservatives and the smaller Liberal Democrat party struck an agreement on Wednesday to form Britain's first coalition government since 1945.


The agreement between the two parties, reached five days after an inconclusive election, ends 13 years of rule by the center-left Labour Party under Tony Blair and his successor Gordon Brown.

The untested partnership will have to tackle a record budget deficit running at more than 11 percent of national output.

Markets welcomed the agreement, hopeful that a government led by the center-right Conservatives will take swift action.

"This is going to be hard and difficult work. A coalition will throw up all sorts of challenges. But I believe together we can provide that strong and stable government that our country needs," Cameron said in his first speech as prime minister.

The Liberal Democrats were also celebrating after decades spent in the shadow of Labour and the Conservatives.

"There will of course be problems, there will of course be glitches. But I will always do my best to prove new politics isn't just possible, it is also better," Liberal Democrat leader Nick Clegg, who will be deputy prime minister, told reporters.

His party put its final seal of approval on the deal at a meeting that ended after midnight on Tuesday.

Cameron, a 43-year-old former public relations executive, took over as prime minister just hours earlier when Brown admitted defeat in his own efforts to broker a deal with the Liberal Democrats.

He is Britain's youngest prime minister in almost 200 years.

The Liberal Democrats have more in common with Labour in policy terms, but talks to form what the media called a "coalition of losers" swiftly fell apart.

Right-leaning British newspapers hailed the deal for ending uncertainty, but the left-leaning press pointed to problems ahead arising from ideological differences between two parties long seen as on opposite sides of the political spectrum.

"The coalition provides Britain with the stable government it needs at a time of economic peril," the Times said, while the Labour-supporting Mirror said "Deep-held grudges, mutual suspicion and opposing agendas will bedevil this cobbled together regime".

The Conservatives are the largest party in parliament after last week's election but fell 20 seats short of an outright majority. Combined with the Liberal Democrats, they will have a majority of 76 seats.

OSBORNE TO BE FINANCE CHIEF

The prime minister's office said late on Tuesday there would be five Liberal Democrats in cabinet in total, including Clegg.

It did not name the other four ministers but there were reports Vince Cable, the well regarded Liberal Democrat Treasury spokesman, would have a role overseeing banking and business.

A Conservative source said the two parties had agreed to accelerate deficit reduction plans significantly. The focus would be more on cutting public spending than on raising taxes.

Another Conservative source said George Osborne, a close friend and ally of Cameron, would become the new Chancellor of the Exchequer (finance minister).

Some in the finance industry have expressed doubts about Osborne because he is untested and takes over an economy emerging from the worst recession since World War Two.

William Hague, a former Conservative leader and one of the main negotiators with the Liberal Democrats, will be foreign minister, and media reports said Liam Fox would be the new defense secretary.