Defence Secretary Geoff Hoon has warned the Cabinet that Britain will have to cut some of its defence commitments unless he gets a £1.5bn increase in his budget.
He is ready for a battle with the Chancellor Gordon Brown who told the Cabinet "away day" in Chequers on Friday to make cuts in their bids to give priority to delivering Labour's promises on the NHS.
Mr Hoon could call on Tony Blair to back him. He is seeking around £500m extra in his budget each year for the next three years. Mr Brown has accused the Ministry of Defence of seeking more while it underspent last year by around £700m.
However, Mr Hoon's budget is likely to be overspent by around £500m this year. The cost of the war in Afghanistan was met from the Treasury contingency reserve and the Treasury will be expected to meet more demands for the war on terrorism elsewhere, such as Iraq.
Tony Blair will use a keynote speech this week on delivering improvements in public services to try to regain a grip on the political agenda after the cash-for-favours scandals.
One of those called into Downing Street last week to be consulted on the speech said it was becoming clear that it could take a third term before services do get better.
"They are very worried in Downing Street about being accused of complacency by saying that it will take a third term to get it right, but that is really the underlying message," said the source.
John Monks, the TUC general secretary, normally a Blair loyalist, yesterday warned the Prime Minister that Labour would lose votes from unionists at the next election because of "an explosive cocktail of issues", including private sector involvement in public services.
In a clear reference to the Liberal Democrats, he said: "Labour is leaving space to its left for one or other of the mainstream parties to occupy."
Charles Kennedy, the Lib Dem leader, will today tell his party he has arranged talks with the TUC leader about public services but will not allow the unions to become their "paymasters".
Labour support for the Government on public services has slumped, according to a Mori poll for the general workers union, the GMB.
The poll showed that those Labour voters who thought public services had got better fell from 29 per cent in November to 18 per cent this month and for all voters, it fell from 20 per cent to 11 per cent, while those who thought services had got worse rose from 34 per cent to 44 per cent.
The Chancellor is keen to leave room in his April 17 Budget to lift one million more children out of poverty. In a speech to the Parliamentary Labour Party last week, Mr Brown told MPs the only case for raising taxation was to pay for tangible improvements in public services.
Treasury sources said that measures to tackle child poverty and family poverty will be at the heart of the Budget statement.
A new Child Tax Credit targeted at children in the poorest families will be introduced next year with the levels set in the coming Budget. So too will a new Working Tax Credit that would increase the income of people on the national minimum wage by an equivalent of £10 a week, and by £35 a week for couples.
The hope is to introduce a guaranteed minimum take-home pay of £128 a week for full-time workers. The rate could be even higher. The move is expected to benefit 500,000 people.
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