Thatcher was ready for Falkland Islands deal, National Archives papers show

Margaret Thatcher was prepared to do a deal with Argentina after the invasion of the Falklands over the status of the islands, including the question of sovereignty, as she came under intense pressure from the US to avoid a military response, government papers released on Friday reveal.

UK government declarations and rhetoric at the time gave the impression that nothing short of the withdrawal of all Argentinian forces, the reaffirmation of British sovereignty and a return to the position as it was before the invasion would be acceptable. But the papers show Thatcher and her senior ministers were privately adopting a more flexible approach, including allowing a continuing Argentinian presence on the islands.

Less than two weeks after the Argentinian invasion on 2 April 1982, Thatcher described a "diplomatic solution" as being "a considerable prize". She was responding specifically to a plan whereby in return for withdrawing its troops Argentina would be represented on an interim commission and on Falkland Islands councils.

Francis Pym, the foreign secretary, is recorded as saying: "It would be a remarkable achievement if this could be brought about, at a time when Britain's military position was still weak."

Asked in private evidence to the subsequent Franks committee of inquiry about her reaction to the invasion, Thatcher said: "I just say it was the worst, I think, moment of my life," the papers reveal. Asked if she was prepared to cede sovereignty over the islands if the islanders agreed, she replied: "Yes".

The disclosure that Thatcher was contemplating a peaceful solution to the Falklands dispute, even after the British taskforce had set sail, is contained in confidential annexes to cabinet minutes released under the so-called 30-year rule.

Sir John Nott, then defence secretary, said on Thursday he had not been against a negotiated settlement if the Argentinian troops left the islands. "I was always prepared to negotiate. It turned out it was not ever possible, but that's a judgment with hindsight," he told the Guardian.

Nott added that Pym was desperate for a negotiated settlement, which had irritated Thatcher. There were plenty of opportunities for a diplomatic settlement but the Argentinian junta was "more intransigent than the prime minister", Nott recalled.

In one paper, stamped Top Secret, Thatcher is recorded as saying that under the plan being discussed by the US and at the UN, "the withdrawal of Argentine forces would have been secured without military action. Argentina would gain representation on the interim commission and on the local councils; and a commitment to negotiations to decide the definitive status of the islands by the end of the year, although without any commitment to a transfer of sovereignty." She added: "Repugnant as it was that the aggressor should gain anything from his aggression, this seemed an acceptable price to pay.

"But it would be crucial to insure against a second invasion and the best way of achieving this appeared to be to involve the United States government in the enforcement of the interim agreement and in the security of the Islands thereafter."

On 19 May, two days before British forces landed on the islands, Thatcher told the war cabinet that in a "sincere attempt to reach agreement to avoid bloodshed", Britain had not insisted on what should be its "full and just demands". Any interim deal, however, must ensure there would be "no prejudgment of the longer-term future".

The war cabinet noted: "In practical terms, administration mattered more than sovereignty."

Even after the British landings, Thatcher's senior advisers were considering how to alter the status of the Falklands and their relationship with the UK. "Some kind of association with the UN – or some kind of Anglo-American trusteeship – could meet our requirements if only the Argentinians could be brought to acquiesce to it," Sir Robert Armstrong, the cabinet secretary, advised Thatcher on 25 May.

He outlined the tactical advantage in preparing for what increasingly seemed an inevitable Argentinian refusal to accept any British offer. That, he suggested, was to publish an account of the diplomatic activity "as a means of wrongfooting them with international opinion by demonstrating our reasonableness".

Any backlash the government might have faced in parliament or the press for doing a deal was avoided by the intransigence of the Argentinian junta. "President [Leopoldo] Galtieri was an alcoholic and apparently incapable of rational thought," ministers were told, according to cabinet minutes on 22 April 1982.

From the start, Britain was under severe pressure from the US to reach a peaceful settlement. Less than a week after the invasion Al Haig, the US secretary of state, told Thatcher it was "important to avoid a priori judgments about sovereignty", according to Foreign Office officials. They reported Haig as saying: "American opinion was now much in favour of our principled stance. But he was not sure this would last long – he remembered Vietnam!"

The papers reveal details of a private telephone conversation between Thatcher and Ronald Reagan, the US president, on 1 June 1982. "President Reagan said the USA considered it imperative that the UK should show that it was prepared to talk before the Argentinians were forced to withdraw," a note said. "As the UK now had the upper hand militarily it should strike a deal now."

Reagan warned that if Britain were "to retain some military occupancy she might face another Argentinian invasion in the future". Thatcher said "she was sure that the president would act in the same way if Alaska had been similarly threatened … self-determination for the islanders had to be the paramount consideration".

Thatcher is recorded as saying as late as 29 May that Britain was "willing to consider change and did not necessarily expect a return to the pre-invasion status quo. The future probably lay in a settlement which did not involve either British or Argentine sovereignty but provided for some form of independence or quasi-independence for the islands."

Many pages have been weeded or redacted from the files.

There is no reference in the minutes of the war cabinet to perhaps the most controversial decision of the war – the order to the captain of the submarine HMS Conqueror to sink the Argentinian cruiser the Belgrano on 2 May 1982.

The decision was taken by an "ad hoc" group of ministers – including Thatcher, William Whitelaw, the home secretary, and Nott – on the margins of a war cabinet meeting at 12.45pm that day.

The decision was taken on the basis of rules of engagement relaxed earlier in relation to the Argentinian aircraft carrier the 25 de Mayo, namely that Argentine ships could be attacked outside the exclusion zone imposed by Britain.

Later controversy centred on the government's initial but erroneous claim that the Belgrano was attacked as it was closing in on the British taskforce. A secret document shows that senior Whitehall officials were unaware of the circumstances surrounding the attack, which led to the loss of 323 lives.

"The point is symptomatic of the difficulty we face in keeping up with ministers, when short cuts are taken," noted John Weston, head of the Foreign Office's defence department, in a secret note a few days after the sinking.