By Adrian Croft & Phil Stewart

NATO chief Anders Fogh Rasmussen urged allies on Thursday to reverse damaging defense-spending cuts once their economies improve as U.S. officials warned of the impact that across-the-board U.S. budget reductions could have on the alliance.

"If defense cuts continue, it will have a negative impact on our ability to provide effective defense and protection of our populations,» Rasmussen told reporters at the start of a NATO defense ministers' meeting.

He appealed to allies, many of which have slashed defense spending in response to the economic crisis, to stop defense cuts, use their resources more efficiently by working together, and to increase defense spending once their economies recover.

He declined to comment directly on $46 billion in U.S. budget cuts scheduled to take effect from March 1 that would slash nearly every U.S. military program or activity by a flat percentage unless Congress acts to avert them.

"But from an overall perspective it is of course a matter of concern that we have seen and continue to see declining defense budgets all over the alliance,» Rasmussen said.

U.S. Defense Secretary Leon Panetta intends to warn NATO allies in Brussels that cuts under the «sequester» - as the mechanism for the across-the-board cuts is known - could impact U.S. contributions to NATO readiness, Pentagon spokesman George Little said.

"We think the alliance's readiness could be diminished if sequestration takes effect,» he told reporters during Panetta's flight to Brussels on Wednesday.

In talks with his Italian counterpart in Brussels on Thursday, Panetta warned «how devastating sequestration would be for U.S. defense and national security», Little said.

While the Obama administration is pushing lawmakers to avert sequestration, Panetta formally notified Congress on Wednesday that the Pentagon plans to put civilian defense employees on unpaid leave this year if the cuts go ahead.

President Barack Obama signed the Budget Control Act in 2011 requiring $487 billion in defense spending cuts over a decade. The law also put in place another $500 billion in mandatory, across-the-board Pentagon cuts.

The cuts were never meant to go into effect, but were intended to coerce Congress and the White House into agreeing on more selective budget reductions. That deal never happened.

The United States, which provides the lion's share of NATO's firepower, has been urging European allies for years to pick up more of the defense burden.

Washington has pressed European countries to take the lead in operations like the 2011 Libya campaign but the Europeans still need U.S. help with key capabilities like air-to-air refueling and intelligence.

The threat of U.S. cuts could give Washington another argument to press European allies to increase defense spending by showing the danger of over-reliance on the United States.

Only a handful of NATO's 28 allies - the United States, Britain and Greece - last year spent more on defense than the two percent of Gross Domestic Product target set by NATO.

Britain, which has cut defense spending to rein in a big budget deficit, also urged allies to commit to increase defense spending once their economies improved.

"I don't hear that commitment as clearly as I would like to hear it (from European allies),» British Defense Secretary Philip Hammond told reporters before the Brussels meeting, which is focusing on Afghanistan and improving NATO's capabilities.

British Prime Minister David Cameron raised the possibility on Thursday of diverting hundreds of millions of pounds from foreign aid to defense and security.

[Reuters]