* Year-long inquiry calls for UK press watchdog backed by law
* Judge says law would enshrine legal duty for free press
* Judge chides some UK press for "outrageous" behaviour
* PM Cameron rejects media legislation, coalition divided
* Murdoch's News International welcomes Cameron's move
* Phone Hacking victims' group says Cameron neutered Leveson
By Michael Holden and Kate Holton
LONDON, Nov 29 (Reuters) - Prime Minister David Cameron rejected the idea of a law to regulate the British press on Thursday, risking a split in his government after an inquiry advised legal backing for a watchdog to police the sometimes outrageous conduct of newspapers.
Opposing an independent regulator enshrined in law will delight the British press ahead of the 2015 election but may raise concern inside the coalition government that Cameron lacks the mettle to stand up to media barons such as Rupert Murdoch.
Cameron said he was wary of writing press regulation into law, a snub to the inquiry he ordered in July last year after public outrage at revelations that one of Murdoch's tabloids hacked the phone messages of a 13-year-old murder victim.
"The issue of principle is that for the first time we would have crossed the rubicon of writing elements of press regulation into the law of the land," Cameron told parliament, watched from the gallery by victims of phone-hacking who have campaigned for tougher rules to police Britain's recalcitrant media.
"I'm not convinced at this stage that statute is necessary," Cameron said, just hours after Lord Justice Brian Leveson reported on his inquiry which laid bare the cosy ties between British leaders, police chiefs and press barons.
Presenting his 1,987-page report opposite the House of Commons, Leveson said he had no intention of undermining three centuries of press freedom but that the press had at times "wreaked havoc with the lives of innocent people" and was sometimes guilty of "outrageous" behaviour.
Leveson said it was essential that there should be legislation to underpin a new independent, self-regulatory body for the press that would be scrutinised by the broadcast regulator Ofcom and have the power to impose fines of up to 1 percent of turnover up to a maximum of 1 million pounds ($1.6 million).
"The ball moves back into the politicians' court: they must now decide who guards the guardians," Leveson said.
The behaviour of Britain's tabloid press has come under imcreasing scrutiny in recent years. While British newspapers were unwilling to report on King Edward VIII's affair with American divorcee Wallis Simpson in the 1930s, their conduct has since become much less restrained in the battle for readers.
As competition intensified, the tabloids turned on the private lives of the royal family, culminating in feverish coverage of Princess Diana, hounded by paparazzi as her marriage to Prince Charles collapsed.
At one point in the early 1990s, a government minister warned the tabloid press that they were "drinking in the last chance saloon". At about the same time the Press Complaints Commission was set up, a self-regulating watchdog now deemed to have failed.
"I know of no organised profession, industry or trade in which the serious failings of the few are overlooked or ignored because of the good done by the many," Leveson said.
'LAST CHANCE SALOON'
While Cameron rejected immediate legislation, the leader of the opposition Labour Party said he supported Leveson's proposals as did Cameron's coalition partner, Deputy Prime Minister Nick Clegg.
"There can be no more last chance saloons," said Labour leader Ed Miliband, opening up the prospect of possible defeat in parliament for Cameron if Labour joined forces with supporters of tougher rules inside the coalition parties.
In a sign of a split at the very heart of government, Clegg said legislation was the only real way to establish a new self-regulatory body for the press.
"Changing the law is the only way to give us all the assurance that the new regulator isn't just independent for a few months or years, but is independent for good," Clegg said.
Victims of phone hacking say the raucous media has been given no less than seven chances to reform in the last 70 years but Leveson said the British press had at times displayed a "reckless disregard for accuracy".
Leveson heard evidence from a host of celebrities including Harry Potter author JK Rowling, singer Charlotte Church and ordinary people who told the inquiry how they had been harassed, bullied, and traumatised by the press.
Hacked Off, an organisation set up to represent victims of press abuse, said it welcomed the Leveson report but warned Cameron's opposition risked neutering the recommendations.
"The prime minister has not done his job. His failure to accept the full recommendations of the report is unfortunate and regrettable," said Brian Cathcart, a former Reuters journalist and founder of the Hacked Off campaign.
"In tearing out from this report the element of scrutiny on the self-regulator, he (Cameron) has left us with only a self-regulator. That is where we were before. That is where we have been for 60 or 70 years."
Ultimately, Cameron took a political decision: powerful ministers in Cameron's party and the majority of the press have said they were adamantly opposed to any form of legislation as they see it as an erosion of press freedom.
Lord Guy Black, currently the head of the body which funds the current discredited, self-regulatory system, said there was no need to subject the new body to a statutory regime.
"Any form of statutory press control in a free society is fraught with danger, totally impractical and would take far too long to implement," he said.
Leveson said the relationship between the cream of Britain's political elite and the press was too close and said he was concerned by lobbying.
The 63-year-old judge warned that the close ties formed between the government and Murdoch's News Corp over the aborted takeover of BSkyB was concerning and had the potential to jeopardise the $12 billion bid.
"We are keen to play our full part, with others in our industry, in creating a new body that commands the confidence of the public," said Tom Mockridge, chief executive of Murdoch's British newspaper arm, News International,
"We believe that this can be achieved without statutory regulation - and welcome the prime minister's rejection of that proposal," Mockridge said in a statement.
Leveson offered little in the way of direct criticism of individuals, ammunition for those who hoped it would condemn Cameron for his links to Murdoch's media empire. Nor did he say there had been any deal between the two.
He said there was no credible evidence of bias on the part of senior minister and Cameron ally Jeremy Hunt in his handling of the BSkyB takeover, but said the close ties allowed a perception of favouritism.
Inquiry hearings embarrassed Cameron by exposing his close ties to executives at Murdoch's British newspaper empire, notably former top lieutenant Rebekah Brooks, who is facing criminal action over phone-hacking and other alleged illegal actions.
Brooks appeared in court earlier on Thursday accused of making illegal payments to public officials.
Four prime ministers including Cameron were quizzed in great detail about their links to newspaper owners, especially Murdoch, who himself endured two days of grilling, during which he denied playing puppet-master to those running the country.