British Prime Minister Gordon Brown has announced that he will step down as Labour leader, as the party begins coalition talks with the Liberal Democrats.

Labour will begin a leadership contest immediately.

In a statement this afternoon, Mr Brown said Labour will soon hold formal talks with the Liberal Democrats - who are already talking to the Conservatives - on forming a government.

Thursday's general election delivered a hung parliament - where no one party has overall control - for the first time since 1974.

The Conservatives won the most seats, but fell short of an overall majority, leaving the Liberal Democrats as kingmakers.

In his statement, Mr Brown said he intended to 'ask the Labour party to set in train the processes needed for its own leadership contest' but he would 'play no part', adding that he hoped the new leader could be in place by September.

Mr Brown's decision to step down will be seen as an olive branch by centre-left Labour to the centrist Lib Dems in a bid to woo them away from the centre-right Conservatives.

He said it was 'in the interests of the whole country to form a progressive coalition government'.

'The reason that we have a hung parliament is that no single party and no single leader was able to win the full support of the country,' Mr Brown said.

'As leader of my party, I must accept that that is a judgment on me. I therefore intend to ask the Labour party to set in train the processes needed for its own leadership election.

'I would hope that it would be completed in time for the new leader to be in post by the time of the Labour Party conference' in September.

He added: 'I will play no part in that contest. I will back no individual candidate.'

Mr Brown's statement comes as Lib Dems demanded fresh ‘clarification’ from the Conservatives in talks on forming a new government.

The biggest potential stumbling block to a deal is likely electoral reform.

The Lib Dems want to scrap the first-past-the-post system, which favours two-party politics and means smaller parties like theirs get fewer seats in the House of Commons. But most Conservatives strongly oppose such changes.

Earlier, Lib Dem leader Nick Clegg told reporters that politicians were ‘working flat out, around the clock’ to secure a deal, promising an announcement ‘as soon as is possible.’

Meanwhile. the Conservatives have offered a major concession to the Liberal Democrats in a bid to seal a power-sharing deal.

Tory negotiator William Hague said his party was prepared to offer a referendum on electoral reform, a key demand of the Liberal Democrats.

The proposal brings negotiations between the Conservatives and Lib Dems to a crunch point but may not be enough to satisfy Liberal Democrats.

'In the interests of trying to create a stable, secure government, we will go the extra mile and we will offer to the Lib Dems in a coalition government the holding of a referendum on the Alternative Voting system,' Mr Hague said.

'That's the choice that they will now have to make.'

The offer came shortly after Gordon Brown's announcement that his party was opening formal talks with the Lib Dems.

The Tory move will be seen as a bid to seize back the initiative in negotiations with the Lib Dems after Labour's bombshell.

But the referendum offer may not go far enough for many Lib Dems.

The Conservatives want a vote on the Alternative Vote electoral system which is seen as less radical than the Single Transferable Vote system which the Lib Dems called for in their manifesto.

If the Tories and Liberal Democrat parties do strike a deal, it would likely pave the way for Mr Cameron to become prime minister.

Labour has been putting pressure on the two opposition parties to announce an accord or admit failure.

The BBC reported that Mr Clegg had met Mr Brown for talks today and that Lib Dem negotiators held parallel talks with senior Labour figures at the weekend.