TONY BLAIR and Gordon Brown have agreed a far-reaching spending deal which could pave the way for a handover of power between them late in 2007, it emerged last night.

After lengthy talks with Mr Blair the Chancellor has instigated a root-and-branch review of all Whitehall spending designed to reset Labour’s priorities for the next ten years.

Its conclusion and announcement in 2007, coinciding with Mr Blair’s anniversary of ten years as Prime Minister, could provide an obvious opportunity for Mr Blair to give up the reins, senior ministers said.

But the growing pressures on Mr Brown to avoid tax rises was underlined as he announced that all departments would be asked to justify their budgets from scratch and suddenly moved the goalposts to ensure that he does not break his “golden” financial rule in the imminent future.

He lengthened the period of the current economic cycle during which he has to balance his budget by the two years between 1997 and 1999, giving him more than £13 billion extra to play with, prompting accusations from the Conservatives that he was “cheating” and “cooking the books”.

Mr Brown announced that the next three-year allocation of spending would be announced in 2007 rather than next year as planned, and that the figures for the current three-year period would remain unchanged.

But in the meantime he is to undertake the second “comprehensive spending review” of Labour’s period in office.

It will amount to a complete reexamination of where the Government spends its money, aimed at ensuring that the available cash goes to the areas which Mr Blair and Mr Brown deem to be its priorities for what one aide called yesterday “new Labour’s second decade”.

Officials are already pointing to extra spending to cope with the growth of the elderly population, more money to go towards science and research to meet the challenges from India and China, housing and transport. As a result spending or waste in other areas will have to be cut. The review will be conducted over the next 12 months with major announcements in July 2006.

Mr Brown’s announcement in the spring of 2007 is being seen by senior ministers as the obvious staging post at which Mr Blair could initiate a Brown succession. Aides say that he will work closely with the Chancellor on the review. This would enable Mr Blair to put his stamp on the next stage of Labour’s journey while having ensured the much-trumpeted “orderly succession” to Mr Brown.

The move reflects the relative changes in Mr Blair’s and Mr Brown’s political fortunes since the election. Immediately afterwards some Labour MPs were calling for Mr Blair’s head because of the sharp fall in his majority. But he has recovered fast with the demise of the European constitution, his crucial role in London’s successful Olympic bid, and the way he has handled the London bombings. Mr Brown has faced criticism over tax credits, the risk of being dragged into the Railtrack row, and constant questioning over his economic forecasts.

George Osborne, the Shadow Chancellor, said Mr Brown had demolished his reputation for fiscal prudence and would not stave off the need to raise taxes. He called for the creation of an independent committee to determine the start and end dates of the economic cycle. “The Iron Chancellor has become the cheating Chancellor. Today’s manoeuvre destroys the credibility of the the golden rule. He has fiddled the figures. It is like giving someone a straitjacket and then also giving them the keys to release the straitjacket. The fact is that he is referee in the game that he is playing.”

CBI chief economist Ian McCafferty said that the Chancellor was simply delaying difficult decisions on tackling the “structural deficit” on the public finances.Peter Spencer, of the independent Ernst & Young ITEM Club, said that the change to the golden rule calculations showed how easy it was to manipulate. “With the Chancellor effectively acting as judge, jury and executioner, it was always going to be hard to secure a conviction under the golden rule in this cycle.”

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