MoD's £2bn cutbacks strike at the heart of BAE

The Ministry of Defence is preparing to make £2bn a year of cutbacks to its spending on new battleships, fighter jets and aircraft carriers - in a move that will hammer the UK's largest arms company, BAE Systems.

Senior defence industry sources have revealed that the ministry wants to make the savings as a result of the huge cost of invading Iraq, pressure from the Treasury and a shift in priorities.

In the forthcoming defence White Paper, the Government will propose a dramatic shift from planes and ships to a greater reliance on hi-tech equipment, such as advanced telecoms.

The paper has been delayed until the autumn because the Defence Secretary, Geoff Hoon, has been tied up with the Hutton inquiry.

MoD officials have already started preparing the ground for the cuts and have told defence companies that the Type 45 Destroyer, the Joint Strike Fighter and the contract for two new aircraft carriers will be the first to be hit.

This will be bad news for the troubled BAE Systems, which relies on the MoD for around 27 per cent of its sales and is involved in all three projects.

The most dramatic cuts will be to the aircraft carriers. BAE controversially won the contract in January, beating off competition from France's Thales. However, project costs have spiralled and the MoD now wants the size of the carriers to be reduced from 65,000 tonnes to 55,000 tonnes, to keep within its original £2.9bn budget.

One source close to the deal said: "The MoD wants costings for both sizes but it has made it very clear that the smaller vessel is now the preferred option."

Slimming down the ships will have a knock-on effect on the MoD's requirement for the new Joint Strike Fighter aircraft, a joint venture between BAE and America's Lockheed Martin. It is understood that the MoD is considering plans to buy 35 jets for each new aircraft carrier instead of the original estimate of up to 50. It is understood that future orders for the Eurofighter aircraft could be scaled back.

The Type 45 Destroyer, which is being built by BAE, VT Group and Rolls-Royce, will also be hit. The Government originally said that it wanted 12 ships to be purchased in two tranches. But senior MoD officials have told contractors that it may now need only 10.

A spokeswoman for the MoD said that the projects' specifications had not been decided on. She added: "It is normal for the MoD to be looking at changes with spending plans at this time of the financial year."

Nick Fothergill, defence analyst at Banc of America Securities, said that the MoD's cuts and similar pressure in the US will hit BAE's profits in future years. He has cut his profit forecast by 3 per cent in 2004, and predicts a "more significant" impact for later years.