The Liberal Democrats need to decide whether to campaign to the left or right of Labour

The conundrum is to devise a message that will appeal to disillusioned voters of each of the other two parties

It may be the quietest August in Westminster for several years, with the Government absolutely determined to keep domestic politics out of the headlines, but, behind the scenes, the Liberal Democrats are busier than ever. Backroom staff, led by chief number-cruncher Lord Rennard, are already laying the foundations for the forthcoming Hartlepool by-election campaign, expected to be held on 7 October - the day on which Michael Howard addresses the Tory party conference. Last week I chanced upon the Montgomeryshire MP, Lembit Opik, who has already made two visits to the constituency.

It may be the quietest August in Westminster for several years, with the Government absolutely determined to keep domestic politics out of the headlines, but, behind the scenes, the Liberal Democrats are busier than ever. Backroom staff, led by chief number-cruncher Lord Rennard, are already laying the foundations for the forthcoming Hartlepool by-election campaign, expected to be held on 7 October - the day on which Michael Howard addresses the Tory party conference. Last week I chanced upon the Montgomeryshire MP, Lembit Opik, who has already made two visits to the constituency.

Lib Dems are masters at the art of illusion. Like the rest of the political class they may appear to be away on holiday, but this is the time of the year when they are at their most dangerous. Last year, attention was focused on the Hutton inquiry proceedings, but while no one else was looking, Lord Rennard was sizing up Brent East, where Lib Dems had previously had no track record of discernible support, for evidence that they could leap frog over the Tories to seize the seat from Labour. The victory came three days before the September Lib Dem conference and provided Charles Kennedy with the evidence that his promise at the 2001 general election (to provide "effective opposition" to Labour during the present Parliament) had been delivered. He will regard the recent gain at Leicester South, and the close result at Hodge Hill, as further proof of making good on this promise.

But the better the Lib Dems do, both in by-elections and in the opinion polls, and the nearer we get to the approaching general election, the greater is the media and voter scrutiny. Mr Kennedy, now fully recovered from his short illness last spring, is acutely aware that next month's conference at Bournemouth will be the most critical of his leadership.

He will be forced at Bournemouth to confront the commentators' question of whether his party will position itself to the left or to the right of Labour. So far, Mr Kennedy has bought himself time by simply abandoning Paddy Ashdown's policy of constructive engagement with Labour. There is little evidence to show, however, that this abandonment has been replaced by the previous stance of political equidistance from the other two parties.

The unequivocal opposition to the Iraq war would seem to suggest that the Lib Dems are happy to be identified as a party to the left of Labour. But Mr Kennedy adamantly resists this simple characterisation and is anxious to point out that many voters - even Tories - feel let down by the failure of the other two front benches to understand the depth of opposition to the war across the political spectrum. He is also determined to dispel the notion that Lib Dems are the new equivalent to "old Labour", having now ditched the 1997 and 2001 election pledges to increase income tax - although the promise to increase the top rate of tax on incomes above £100,000 to 50p in the pound still stands and would be expected to find favour among traditional Labour supporters.

The conundrum - as so many of his party's target seats are divided between Tory and Labour - is how to devise a political message that will appeal to disillusioned voters of each of the other two parties. This has been exercising a number of the newer and younger members of the frontbench team, who are expected to publish a pamphlet at the forthcoming conference entitled The Orange Book: Reclaiming Liberalism. The editor is David Laws, who only entered Parliament in 2001 for Lord Ashdown's Yeovil seat, and is already the party's shadow chief secretary to the Treasury. On economic policy there is expected to be a decidedly aggressive support for choice and the acknowledgement of the realities of the free market.

At one level this would seem to mark a shift away from the "leftist" tinge that has characterised Lib Dem policy during the past 20 years, but many might believe this is also a return to the older traditions of the 19th-century Liberal Party of Gladstone, Cobden and Bright. The free market, with minimal government interference and regulation, was historically the preserve of the Liberals long before this territory was colonised by Margaret Thatcher. Free trade was the natural tradition for Liberals of the industrial revolution, while Tories were historically labelled as the protectionists of the agrarian interest.

Mark Oaten, the Lib Dem victor of Winchester in 1997, who is now Home Affairs spokesman, is also expected to contribute to the pamphlet. He will be likely to strike out from the recent past by making the case for "tough liberalism" on law and order. His recent refusal in a BBC interview to castigate David Blunkett over the extension of telephone tapping is a tacit acknowledgement that the Lib Dems have a reputation as "wishy washy", which needs refining if the party is to make inroads into further Tory territory.

But Mr Oaten also recognises that the party's new electoral push in run-down, crime-ridden Labour inner-city areas will not be assisted unless Lib Dems apply limits to their hitherto sacred belief in the legalisation of certain class-C drugs. The delightful dottiness of the conference delegates will probably give a lively response to his tougher approach. But it is a sign of the growing strength of these "Young Turks" on the front bench that they are prepared to challenge the recent nostrums of the conference delegates.

It is popularly supposed that Lib Dems have to appeal to Tory voters in Tory seats they hope to win and to Labour voters in Labour seats that are within their sights. Actually, under our electoral system the reverse is often the reality. To win in a Tory-held constituency, providing the party can establish its credentials over Labour as the main challenger, it is to Labour voters the party needs to appeal.

Tory Shadow Cabinet members, such as David Davis, Oliver Letwin and Theresa May can hold - or even increase - their vote but none the less lose if Lib Dems can appeal to Labour voters who cannot stand Tony Blair, are opposed to the war in Iraq and are quite happy to claim a big Tory scalp. Conversely, in Labour seats, Tory voters need to be persuaded that Lib Dems will be tough on crime - and even on Europe.

Left or right? Mr Kennedy will steadfastly refuse to put the party in either category. Speaking recently on Breakfast with Frost, he claimed that today's voters no longer think of politics in such terms. Among the generation of voters who cannot remember the defining issues of the Cold War or the battles over nationalisation versus free enterprise, these conventional terms are not even understood, let alone worn as a badge of political identity.

But neither Mr Kennedy nor his "Young Turks" can forever avoid answering the question as to what they would do if three-party politics should result in the inability of either Labour or the Tories to form a majority government after a general election. The bigger the Lib Dem advance the more acute this question will become.

mrbrown@pimlico.freeserve.co.uk