After welfare U-turn, Osborne faces more hurdles to top UK job

By William Schomberg and William James

LONDON (Reuters) - British finance minister George Osborne has fixed a big mistake of his own making by ditching an unpopular part of his austerity drive, but he still faces hurdles in his bid to become the country's next prime minister.

Osborne has sat at David Cameron's side since their days in opposition, and Cameron has allowed him to appear as his heir apparent and make headline-grabbing announcements on issues far beyond his brief such as national intelligence and Syria.

His miscalculation in proposing a plan to cut tax credits for low-earning households raised questions about Osborne's judgement as the most trusted political strategist of Cameron, who has said he will stand down before the 2020 election.

An opinion poll of supporters of their Conservative Party published last week showed he had slipped to third place among potential next leaders of the party, behind London Mayor Boris Johnson and Home Secretary Theresa May.

Andrew Gimson, a biographer of Johnson and writer for Conservative grassroots website ConservativeHome, said Osborne's influence across the government was a double-edged sword.

"He's deeply involved in just about everything. He sets a very high value on controlling stuff," Gimson said. But that means there will be "nowhere to hide" if the government makes mistakes between now and the next election in 2020.

One event that could blow his ambitions out of the water is Cameron's planned referendum on whether Britain should stay in the European Union. The pro-European Osborne is overseeing London's negotiations with Brussels, and his fate may hang partly on the outcome of the unpredictable plebiscite.

Osborne, 44, tried to limit the damage from the tax credit U-turn on Wednesday, saying he was responding to concerns about the plan and was dropping it. That surprised even his supporters who had expected him to say he would introduce it more slowly.

Now he has to persuade voters that his target of turning a budget deficit into a surplus over the next four years, mainly through big spending cuts on public services, remains a price worth paying.

Watching closely are his rivals for the Conservative Party leadership, chief among them Johnson, who voiced concerns early about the tax credit plan.

AN END TO AUSTERITY? NO

Showing sensitivity to worries among voters and some Conservative MPs about what will be a decade-long spending squeeze, Osborne used a surprise windfall in projected tax revenues to soften the pace of forthcoming public spending cuts.

He originally planned to have finished his austerity drive and balanced the budget by now. At least five times in media interviews on Thursday, he declared there is "light at the end of the tunnel".

The less draconian-looking cuts prompted the Daily Mail newspaper to ask: "Whatever happened to austerity?"

But some budget experts warned that tough times still lie ahead, leaving the Oxford-educated Osborne, who likes to appear on television in a luminous yellow builder's jacket on construction sites, at risk of austerity-fatigue among voters.

"This is not the end of 'austerity'. This spending review is still one of the tightest in post war history," said Paul Johnson, head of Institute for Fiscal Studies, a non-partisan think tank.

Public spending is set to fall from 40.9 percent of national income this year to 36.5 percent by 2020 - a lower proportion than in any European Union country except impoverished former communist states Romania and Lithuania.

Despite the U-turn on tax credits and softer cuts for some government departments, Osborne is sticking to his big welfare savings target between now and 2020, and anti-austerity campaigners are already gearing up for that fight.

The ability to deliver his target of 12 billion pounds of welfare savings is tied up with a complicated reform which would bundle various benefits into a single Universal Credit programme which is running behind schedule.

"More than ever is now riding on the rollout of the ambitious Universal Credit system," said Frank Field, a Labour lawmaker whose views on welfare issues are respected by the Conservatives.

Yet, buried in the hundreds of pages of documents that accompanied Osborne's announcement was news of a further delay to the implementation of that new system, he said.

ECONOMY STUPID?

More broadly, the biggest risk for Osborne is that the recovery in Britain's economic recovery does not last.

As Chancellor, Osborne's fortunes are closely tied to the ups and downs of the economy. After growing strongly in the last two years, it has started to lose some of its pace and could be affected more severely if the global slowdown deepens.

David Tinsley, an economist at UBS, said a new payroll tax announced on Wednesday to help pay for apprenticeships could add to strains on companies which are already worried about a higher minimum wage that Osborne announced earlier this year.

The planned EU referendum is another minefield for Osborne, who has been trying to persuade Britain's partners to grant it looser membership terms and let it deprive newly arrived EU migrants of benefits before an in-out vote due to take place before the end of the 2017.

"If things go horribly wrong and people vote to leave, then Cameron's leadership obviously ends on a low and a defeat, but Osborne is the Cameron-continuity candidate," Anthony Wells, research director at polling firm YouGov said.

Gimson said there was also a risk that voters by 2020 will simply have tired of Osborne after what will have been a decade near the top of British politics.

"No front-runner has won the Tory leadership since 1955," he said. "I suppose people sometimes get bored of the front runner."

(Writing by William Schomberg; additional reporting by David Milliken; editing by Guy Faulconbridge and Paul Taylor)