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UPDATE 2-Cameron warns Britons to expect more budget cuts

* UK faces choice of deeper cuts or longer austerity

* PM Cameron says he will not waver in cutting deficit

* Cameron appeals to powerful anti-EU Conservatives

* UK will block aerospace merger if "red line" prioritiesnot met

(Adds defence minister's comments)

By Guy Faulconbridge and Matt Falloon

BIRMINGHAM, England, Oct 7 (Reuters) - Britain will have tokeep cutting public spending to reduce the budget deficit, PrimeMinister David Cameron said on Sunday, underlining thegovernment's tough task of pulling the country out of recessionwhile winning back waning public support.

Cameron cited the euro zone crisis in explaining theproblems facing the British economy, comments which are likelyto please the influential eurosceptic wing of his Conservativesas they gather for the party's annual conference.

"It is a very challenging situation, you only have to switchon your television set and look at what is happening in the eurozone. We have got many countries going into quite a deeprecession, these are very difficult times," Cameron said.

An aide said the government was paving the way for the nextphase of austerity rather than signalling bigger than plannedmeasures, but economists say longer or deeper cuts look likelyafter a return to recession cast doubt over its deficit targets.

The next election in 2015 will be fought on the economy andhow best to get the deficit, which peaked at 11 percent of thenation's annual economic output, under control. Cameron'sConservative-led coalition planned to all but erase the deficitby 2015 but has been forced to project two more years of cuts.

Underlying borrowing between April and August was a fifthhigher than last year, suggesting that either bigger cuts or afurther extension of austerity could be on the cards when thegovernment updates its economic forecasts on Dec. 5.

"We inherited a budget deficit at around 11 percent, it isdown to 8 percent," Cameron told the BBC. Referring to thisyear, he added: "It is too early to say where they will end up."

Official figures in March predicted a fall to below 6percent this year, a target which now looks uncertain.

Abandoning the austerity plan would prove politicallydisastrous for the Conservatives, who staked their 2010 electioncampaign on it.

"The economy is healing. But it's a longer and harder roadthat we have to travel down," finance minister George Osbornetold the Mail on Sunday. "There will have to be further cuts."

COALITION TENSIONS

The Labour opposition has pulled ahead of the Conservativesdue to public anger about the austerity drive, while support hasdived for the junior coalition partner, the Liberal Democrats.

Pollsters say Cameron will struggle to win an outrightmajority in 2015 unless the economy bounces back and theausterity plan starts to bear fruit.

Labour - which holds a 10 percentage point poll lead - andthe Lib Dems want the wealthy to make a bigger contribution toreducing government borrowing.

But the Conservatives dismissed the idea of a tax on thewealthy - such as on expensive homes - and called for more cutsin welfare spending, comments likely to create further tensionin an already uneasy coalition.

In an effort to woo back middle class voters, Cameron alsoannounced a freeze in a tax that pays for local services and acap on rail fare increases.

"If we want to avoid cuts in things like hospitals andschools and the services that we all rely on, we have to look atthings like the welfare budget," he said.

Beyond the economy, Cameron also faces problems in hiscentre-right party, with some arguing he has not taken a toughenough line on the European Union and a few calling for a newleader, such as Boris Johnson, the Conservative London Mayor.

To pacify anti-EU Conservatives, Cameron threatened to useBritain's veto if the bloc tries to inflate its 2014-2020budget. He suggested the EU should at some point split itsbudget into two - one for the euro zone and one for thecountries outside the common currency, including Britain.

Cameron used the veto last year to keep Britain out of aEuropean fiscal and economic pact aimed at resolving the eurozone debt crisis.

"People in Europe know I mean what I say. I sat round thattable - 27 countries, 26 of them signing up to a treaty - and Isaid this is not in Britain's interest," he said.

"I don't care how much pressure you put on, I'm not signing,we are not having it. They know what I am capable of saying, no,and if I don't get a good deal I'll say no again."

Defence Minister Philip Hammond also raised sensitiveeconomic relations with EU powers, saying his government wouldblock a proposed $45 billion merger between Airbus maker EADS

and British defence group BAE Systems if "redline" priorities were not met.

Tensions have spilled into the open in recent days asFrance, Britain and Germany jockey over the role of the state inwhat would be the world's largest aerospace group.

"It is not necessary to have no French or German governmentinterest in the company. It is necessary to reduce that stakebelow the level at which it can control or direct the way thecompany acts," Hammond told BBC radio.

(Additional reporting by Tim Castle; Writing by David Stamp andMatt Falloon; Editing by Alison Williams)

((matt.falloon@thomsonreuters.com))

Keywords: BRITAIN POLITICS/