Tony Blair is preparing himself for the defining moment of his post-prime ministerial career as Whitehall sources confirmed that Sir John Chilcot will publish his report into the handling of the Iraq war in the new year.

A compromise agreement between Chilcot and the cabinet secretary Sir Jeremy Heywood, who had been resisting calls for the publication of correspondence between Blair and George Bush, is understood to mean that the final stages of the inquiry can be started in the new year.

Chilcot, a former permanent secretary at the Northern Ireland Office who had demanded the publication of the correspondence, is expected to press ahead with the "Maxwellisation process" in which people criticised in the report are contacted for their comments.

The inquiry sent out what were described as "boilerplate" letters in the initial stages of the "Maxwellisation process" in the autumn. But this process, named after rules introduced after the late Robert Maxwell was deemed in an official 1969 report to be unfit to run a public company, was put on hold by Chilcot in November after he reached an impasse with Heywood on publishing the highly sensitive correspondence. Extracts of the correspondence are now expected to be published in the report in redacted form.

A senior Whitehall source told the Guardian: "In the new year it seems the Chilcot inquiry is going to be published. Everyone will be assuming: bad hair day for Tony Blair and Jack Straw. The Conservatives can't say or do very much given that Iain Duncan Smith was further ahead than Blair. But the Conservatives are irrelevant to it."

Lord Mandelson, the former business secretary who remains close to Blair, indicated recently that the former prime minister's inner circle expect the report to be published within months. Mandelson told the Andrew Marr Show on BBC1 just before Christmas: "Ed Miliband … has to navigate his way through what could be a very difficult minefield, and that is the Chilcot inquiry into the Iraq war, which remains a very sensitive issue for many in the Labour party, but also many in the public."

Asked when he expected the report to be published, the former cabinet minister said: "I think we expect it somewhere in mid-year. It's certainly taken its time."

Blair's office and the Iraq inquiry declined last night to comment on the timing of the publication of the report. But it is understood that the former prime minister is relaxed about the publication of his correspondence with Bush. Some friends of Blair say that the report would lack credibility unless the correspondence is published.

In his evidence to the inquiry Blair said it was important to protect the confidentiality of correspondence between a prime minister and a president. But friends point out that Blair went out of his way to explain the correspondence without breaking confidences.

A crucial communication between Blair and Bush was a note in July 2002 which gave the impression than the then prime minister had indicated that Britain would back the US in a military campaign to remove Saddam Hussein from power. Sir David Manning, his chief foreign affairs adviser, had told Blair that his original draft was "too sweeping" and "went further than we should have gone".

Blair told the inquiry that he had offered strong support for Bush but insisted that he still wanted the US to try for further UN security resolutions – something Bush announced two months later in a speech to the UN general assembly. He told Chilcot: "In a sense what I was saying to America was: 'Look' – and by the way I am absolutely sure this is how George Bush took it – 'whatever the political heat, if I think this is the right thing to do I am going to be with you. I am not going to back out because the going gets tough. On the other hand, here are the difficulties and this is why I think the UN route is the right way to go".

Whitehall is assuming that the report will criticise Blair, his foreign secretary Jack Straw, the former prime minister Gordon Brown and Sir Richard Dearlove who was head of MI6 at the time of the Iraq war. Chilcot was a member of the commission chaired by the former cabinet secretary Lord Butler of Brockwell which was highly critical of the use of intelligence in the runup to the war.

But one Whitehall source said that the report will also have implications for politics today. "The report will reinforce MPs who are demanding an even greater say of the legislature over the executive. They will want to have this set in concrete. They will be saying among other things – and it will be more difficult for the government to defend – confirmation hearings for chief of the defence staff, for senior ambassadors, the ability to summon the national security council here."

• This article was amended on 30 December, 2013. The original erroneously knighted Robert Maxwell. This has been corrected.