David Cameron is expected to announce next week that he is killing off the coalition's plans to reform the House of Lords.
The Prime Minister had promised "one more try" to rescue the reform Bill, which has been driven by Nick Clegg, after a major Tory rebellion last month.
But the Government is now said to be preparing to shelve the plans, which would slash the number of peers and make the chamber 80% elected.
The move will open the door to retaliation by the Lib Dems, who have already warned they could block boundary changes that could hand the Tories an extra 20 seats at the next election.
A Lib Dem spokesman made clear there would be "consequences" for a failure to see through the constitutional change, which the party has insisted is part of the coalition agreement.
"Our position is pretty well established on what would happen if they failed to deliver. A deal is a deal," the spokesman said.
He also dismissed the possibility that the junior coalition partner would accept the U-turn if they are given other concessions on energy or party finance as "for the birds".
Last month, the Government was forced to drop a timetable motion for the Bill, which would have restricted Parliamentary debate, because of dissent in the Tory ranks.
A vote on the Bill itself went ahead and was passed because of Labour support but 91 Tories still rebelled.
Mr Cameron is now thought to have come to the decision that he has no chance of winning round enough rebels to ensure a new timetable motion would be passed in September.
However, Lords reform is seen as particularly important for Mr Clegg because he has already lost a referendum on another key constitutional policy - changing the voting system to AV.
After a bruising few months for both parties, senior figures across the coalition are now working on a new agreement to cover policies for the next two years.
As well as angering the Lib Dems, axing Lords reform could also embolden voices on the Tory backbenches.
Shadow justice secretary Sadiq Khan said: "Nick Clegg marched his MPs through the voting lobbies in support of the harsh and unfair policies of this Tory-led Government in anticipation of receiving Lords reform in return.
"But now Nick Clegg may end up with nothing, ruthlessly exposing his naivety. Millions of people struggling through the tough economic times will question his political priorities."
Electoral Reform Society chief executive Katie Ghose said: "This reform is vital for Britain to hold its head up as a modern democracy but it is being sabotaged by MPs who think it will work against their own interests.
"The second chamber makes laws about life in Britain, it should belong to the British public and not be a play-thing for politicians to use in their squabbling with each other."