The Liberal Democrats agreed on Wednesday to rule with the larger Conservatives under new Prime Minister David Cameron in 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 clean up public finances, with 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 to bring down spending.

'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.

'Hooray,' former Liberal Democrat leader Paddy Ashdown said as he emerged from a late night meeting at which the party put its final seal of approval on the deal.

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

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.

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.

The prime minister's office announced late on Tuesday there would be five Liberal Democrats in cabinet in total, including party leader Nick Clegg who will be deputy prime minister.

A Conservative source said the two parties had agreed to significantly accelerate deficit reduction plans. 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.

The Conservative source said William Hague, a former Conservative leader and one of the main negotiators with the Liberal Democrats, would be the foreign minister. - Reuters