BAE Systems, the UK's leading defence contractor, could lose out to its French rival on a �10bn contract to build two new Royal Navy aircraft carriers, according to reports.

The group is also at the centre of speculation that it is considering a merger with the US aerospace giant, Boeing.

The UK government is expected to meet on Thursday to discuss recommendations for the defence contract, one of the biggest in decades.

But the Independent on Sunday newspaper suggested the Ministry of Defence will recommend that it be awarded to Thales, the French defence firm.

Meanwhile, the Sunday Telegraph also suggested the government has refused to set a �1bn limit on BAE's potential losses on contracts to build Astute submarines and Nimrod surveillance aircraft.

'Stand-off'

The Sunday Telegraph described the situation between the government and BAE as a 'stand-off'. Refusing to set a limit on the losses will make it very difficult for BAE to publish its accounts when they are due in February

The company's share price collapsed in December when it revealed the extent of the cost over-runs on the projects.

The dispute comes at a difficult time. The MoD Investment Approvals Board is due to meet on Thursday to make an initial decision on who should be awarded the new aircraft carrier contract.

The Sunday Telegraph suggested the board would argue that the Thales bid represented better value for money and was technically superior in certain areas.

Comments last week from the defence secretary Geoff Hoon that BAE is no longer British, because 54% of its shares are in foreign ownership, has also fuelled speculation that Thales will win.

Losing the contract, which is expected to create about 10,000 jobs, could cast doubt over the future of BAE's two Glasgow shipyards at Govan and Scotstoun.

The newspaper suggested it could also lead to BAE 'turning its back' on the UK defence market to focus on winning business from the US government.

Over the pond

The Sunday Times goes even further, suggesting BAE is considering a tie-up with the US group Boeing.

The two groups are believed to have entered into discussions last autumn, but put them on hold following BAE's profit warning in December.

BAE refused to comment on the speculation but reportedly said it has made no secret of its intentions to increase its exposure in America.