British Airways has announced plans for a merger with Spanish airline and long-term partner Iberia.
BA said both brands would be retained under the deal as part of a new enlarged group, which would be listed on London's FTSE 100 Index and the Madrid stock exchange.
The boards of both airlines have unanimously supported the tie-up, although shareholders will still need to approve the deal.
BA shares soared as investors cheered news of the merger talks.
BA chief executive Willie Walsh said the two companies were a good fit and that consolidation in the airline industry was "long overdue".
"The combined balance sheet, anticipated synergies and network fit between the airlines make a merger an attractive proposition, particularly in the current economic environment," he said.
"We've had a successful relationship with Iberia for a decade and are confident that both companies' shareholders would benefit from the proposed tie-up."
BA already owns a 13.15% stake in Iberia after increasing its shareholding in recent months.
Speculation had been mounting over BA's plans for a closer alliance with Iberia.
The airline signalled nearly five years ago that it was interested in a merger with the Spanish carrier and was previously part of a consortium looking at bidding for the group.
Virgin Atlantic Airways spokesman Paul Charles said: "This tie-up between the two airlines will only fuel BA's dominance at Heathrow Airport, where it has 44% of the take-off and landing slots.
"Consumers will be worse off, as we all know that dominant airlines simply raise fares."
A new holding company would be set up to buy the two firms as part of the all-share merger, but BA and Iberia would continue to be responsible for day-to-day running of their operations.
The merger is expected to take several months to complete, with details on the terms of the merger and integration plans still to be hammered out.
Iberia's chairman and chief executive Fernando Conte said: "A merger would be good news for our customers and enhance our existing relationship. We've worked together for nearly 10 years and a tie-up would build on that success."
The two firms are partners under the Oneworld Alliance of airlines, with joint marketing "code-sharing" agreements on 30 routes.
BA has held shares in Iberia since 1999, while Iberia recently bought a 2.99% holding in BA and exposure to a further 6.99% through financial instruments.
However, the two firms will have to win support from shareholders for the deal, including Iberia's largest shareholder Caja Madrid, the Spanish bank which owns a near-23% stake.
Caja Madrid gave a hostile response to BA's previous approach for Iberia as part of last year's bidding consortium.
The five-member consortium withdrew its interest in Iberia after Caja Madrid reportedly indicated it would like to see the airline kept out of foreign hands.
BA has been seeking to win-over Caja's support and confirmed in March that a BA management team had travelled to Spain to talk with Caja Madrid executives.
BA and Caja Madrid have, as core Iberia shareholders, rights of first refusal on each other's stakes.
Iberia is Spain's largest air transport group and the fourth-largest in Europe. It is also a significant provider of services on routes between Europe and Latin America, with the most flights and destinations. The group employs around 25,000 people.