Osborne confirms pay and jobs pain as growth slows

Chancellor George Osborne has said public sector pay rises will be capped at 1% for two years, as he lowered growth forecasts for the UK economy.

The number of public sector jobs set to be lost by 2017 has also been revised up from 400,000 to 710,000.

Borrowing and unemployment are set to be higher than forecast and spending cuts to carry on to 2017, he admitted.

For Labour, Ed Balls said the figures showed the chancellor's economic and fiscal plans were "in tatters".

Outlining his plans to MPs, based on economic forecasts from the independent Office for Budget Responsibility (OBR), Mr Osborne told MPs the UK economy was now forecast to grow by 0.9% this year - compared with 1.7% forecast in March and 0.7% next year, down from the 2.5%.

He said the eurozone crisis, a hike in global commodity prices and a new assessment that the UK's economic boom was bigger and the bust deeper than previously believed was to blame.

Borrowing was falling and debt would come down but "not as quickly as we wished". In 2011-12 borrowing is now forecast to be £127bn - up from £122bn forecast in the Budget and, over five years, the government is expected to borrow £111bn more than predicted in March.

But he said, because debt interest payments had dropped, the government would be spending £22bn less over this Parliament on that than predicted.

The OBR forecast that unemployment would rise from 8.1% this year, to 8.7% next year - before falling to 6.2% by 2016. Its earlier prediction that a squeeze on the public sector would mean 400,000 job losses over five years has been nearly doubled, to 710,000 - as a result of extra spending cuts pencilled in for 2015-16, and 2016-17.

Chief Secretary to the Treasury Danny Alexander later told BBC Newsnight that the government did not yet know where the bulk of the £30bn additional cuts - £1.2bn of which is expected to come from changes to tax credits - would come from.

He said: "We haven't decided where those cuts will come from. It doesn't have to be found quickly, that is in 2015-16 and 2016-17. In good time, well before the next election, we will set out precisely what the measures are to deliver those additional savings in the next Parliament."

The chancellor conceded he would not now be able to eliminate the structural deficit and see national debt falling by 2014/15 as had been predicted. The structural deficit is now predicted to be eliminated by 2015-16, pushing it beyond the next general election.

While the OBR had not forecast a double dip recession - as the economic think tank the OECD did on Monday - the chancellor warned that if the rest of Europe went into recession, "it may prove hard to avoid one here".

But he said the government would meet its budget rules.

Mr Osborne said: "Much of Europe now appears to be heading into a recession caused by a chronic lack of confidence in the ability of countries to deal with their debts.

"We will do whatever it takes to protect Britain from this debt storm while doing all we can to build the foundations of future growth."

BBC News Channel chief political correspondent Norman Smith said many would be surprised by the scale of the pain ahead, with difficult austerity measures planned even after the next election and a big squeeze on living standards, with the OBR predicting no significant rise in disposable income before 2014 and a post-war record fall in incomes this year.

Among money-saving measures outlined by the chancellor were a 1% cap on public sector pay for two years, once the current two-year pay freeze ends from 2013 - Mr Osborne said the government "cannot afford the 2% rise assumed by some government departments thereafter". That would save more than £1bn by 2014-15, he said.

He acknowledged a 1% cap was "tough" but said many public sector workers would be helped by "pay progression" - annual increases in salary grades - even when pay was frozen.

Plans to raise the state pension age from 66 to 67 would be brought forward by eight years to 2026, to save £59bn in the long term.

The child element of child tax credit and the disability elements of tax credit will be uprated in line with inflation, but other tax credit increases will be restricted.

But in April there will be a £5.30 increase in the basic state pension to £107.45, in line with the 5.2% inflation rise in September.

Pensioners receiving pension credit will also benefit from an increase worth £5.35 and "working age" benefits would also go up in line with the higher inflation figure - contrary to earlier reports - which he said would be a "significant boost to the incomes of the poorest".

Other announcements included an increase in the bank levy to 0.088% from 1 January and a 50% discount for social housing tenants who want to buy their own home - the proceeds of which would go towards building new affordable homes.

Mr Osborne also went through a series of schemes aimed at boosting the UK's flagging economy.

These include a £20bn national loan guarantee scheme for small businesses, a £40bn "credit easing" scheme to underwrite bank loans to small businesses, plans for £5bn spending on big infrastructure projects over three years - with 35 road and rail schemes identified, £400m fund to kick start housing projects, an extended business rate holiday for small firms and an extra £1.2bn for schools in England.

Rail fares, and fares for the Tube and London buses, will be capped at inflation plus 1% while the fuel duty rise for January has been axed and a planned 5p rise in August limited to 3p. Free nursery care targeted at two-year-olds from poorer families will be extended to 260,000 toddlers and Mr Osborne confirmed a £940m scheme to target youth unemployment by subsidising work placements in the private sector.

Overseas aid will be adjusted as it is currently on track to surpass the government's commitment to raise it to 0.7% of GDP, which Mr Osborne said could not be justified in the current circumstances.

But for Labour, shadow chancellor Ed Balls said the figures showed the "truly colossal failure of the chancellor's plan".

"Let's be clear what the OBR has told us today: Growth flatlining, down this year, next year and the year after. Unemployment rising, well over £100bn more borrowing than the chancellor planned a year ago - more borrowing that the plan which the chancellor inherited at the last general election.

"As a result his economic and fiscal strategy is in tatters."

On the issue of public sector pay, TUC general secretary Brendan Barber said: "The chancellor's refusal to back a Robin Hood tax, and make nurses pay instead, speaks volumes about his values.

"Public servants are no longer being asked to make a temporary sacrifice, but accept a permanent deep cut in their living standards that will add up to over 16% by 2015 when you include pay and pension contributions."