As part of the deal it has bought just under a third of Telewest - one of the largest cable companies in the UK.

The move forms part of Microsoft's bid to become an influential player in the UK cable business as the industry gears up to provide customers with both Internet access and digital television services.

Powerful deal

Microsoft now appears determined to be at the forefront of the rapid developments in the international cable industry.

Under the new agreement AT&T will use Microsoft software to power millions of television set top boxes which will bring high speed internet access, e-mails and interactive services to US homes.

AT&T, already committed to use a Windows CE-based system in five million television set-top boxes, will raise that number by between 50% and 100% under the terms of the agreement.

The agreement comes hot on the heels of AT&T's $54bn acquisition of cable group MediaOne - giving it access to 25 million homes

Cable connections

Microsoft is purchasing MediaOne's 29.9% stake in Telewest from AT&T. It has already invested $500m in UK cable rival NTL, reflecting its belief in cable as the future means of Internet delivery.

Telewest shares were up 31p to 285p following the announcement.

Microsoft's move is a blow to Sun Microsystems and America Online who are competing head to head with Bill Gates' software empire to supply the technology for high-speed Internet access, telephone and television services.

"We're gratified that Microsoft shares our strategy of using broadband cable to bring a new generation of digital communications, information and entertainment services to millions of American families," said AT&T chairman Michael Armstrong.

"Our agreement today represents an important step in Microsoft's vision of making the Web lifestyle a reality," said Microsoft chairman and chief executive Bill Gates.

Co-operation not conflict

The talks with AT&T were prompted by Microsoft's interest in bidding for MediaOne, which had been planning to merge with another cable operator, Comcast, in which Microsoft has a stake.

But instead of engaging in a bidding war with AT&T, Comcast conceded defeat in return for the opportunity to buy two million additional cable customers.

Rapid consolidation

The swift moves to forge alliances in the fast-growing telecommunications industry is causing concern among rivals and regulators.

"AT&T is putting together a cable monopoly ... now that they have cornered the network, they are putting it under lock and key by putting Microsoft technology inside the set-top box," said Gregory Simon of the Open Net Coalition.

At stake is the control of the future of the Internet, with AT&T aiming to create a broadband network of fibre optic cables that can deliver online services at download times hundreds of times faster than current modems.

It appears to have stolen a march on its regional telephone rivals, who are still planning to deliver such services over ordinary telephone lines.

AT&T's acquisition of MediaOne also gives its links with the other major US cable operator Time Warner, and could lead to a merger of the two rival high-speed Internet providers, Time's Roadrunner and AT&T's @home.