Chancellor George Osborne has revealed official growth forecasts have been slashed and admitted the Government is preparing in case Britain slides into a double-dip recession.
The Office for Budget Responsibility (OBR) is now predicting the economy will only grow by 0.9% this year, down from a previous estimate of 1.7%.
It also forecasts growth of 0.7% next year – a sharp downgrade on its March prediction of 2.5%.
In his Autumn Statement, Mr Osborne said the OBR had found the debt challenge was “even greater than we thought because the boom was even bigger, the bust even deeper and the effects will last even longer”.
The watchdog now predicts the structural deficit will not be eliminated until 2016/17, putting it well beyond the next general election.
The Chancellor vowed the coalition would do everything possible to protect the UK from the “debt storm” engulfing the eurozone but warned it would be difficult to avoid a new recession if no solution is found.
He outlined a series of measures aimed at promoting growth, helping struggling families and boosting business – including eye-catching freezes in fuel duty and limits on rail fare rises.
But there was more woe for the public sector ahead of Wednesday’s industrial action over pensions, with workers facing a cap on average pay rises of 1% for two years once the current pay freeze ends.
The OBR has also warned that as many as 600,000 jobs could be lost from the public sector by 2015/16 – a dramatic increase on its previous estimate of 400,000. By the following year, the figure could reach 710,000.
In good news for households, fuel duty will no longer rise in January and it will only rise by 3p in August. Meanwhile, rail fare increases have also been capped at 1% above inflation.
The basic state pension will rise by £5.30 to £107.45, while those pensioners receiving pension credit will also benefit from an increase worth £5.35.
Work-related benefits will also be uprated in line with the CPI inflation rate of 5.2% recorded in September, Mr Osborne confirmed.
However, some of the money will be clawed back by holding down increases in elements of the tax credit system.
To help small businesses, the Chancellor also announced a six-month extension to the current business rate relief holiday, taking it to April 2013.
He said a £50m fund for small business risk capital will help companies setting up in the areas worst affected by spending cuts.
Investors supporting firms with fewer than 25 employees will be eligible for 50% income tax relief on the money they invest up to £100,000 a year, and will receive a one-year capital gains tax holiday.
The Chancellor said: “In this tough time, we are helping where we can.”
Mr Osborne told MPs the OBR was not predicting the UK would suffer a double-dip recession, as the Organisation for Economic Co-operation and Development (OECD) did earlier this week.
But he warned it would be difficult to avoid another recession in the UK if the rest of Europe starts contracting and said the Government was already planning for “all the potential outcomes” of the euro crisis.
The Chancellor 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.”
The lower growth figures are a major blow to the Chancellor and the coalition, which had been banking on a growing private sector compensating for the deep spending cuts.
Shadow chancellor Ed Balls said they showed the economy was flatlining and had suffered “all of the pain and none of the gain” at the Government’s hands.
He claimed the coalition’s austerity agenda had been “entirely counter-productive and self-defeating”, adding: “Plan A has failed and it’s failed colossally,”
Mr Osborne admitted the stalling recovery means the Government is now set to borrow £111bn more than planned over the next five years to plug the gap.
The limits on public sector pay rises to 1% on average for two years after the current freeze ends will help save money but risks deepening the rift with the unions ahead of a major strike over pensions tomorrow.
The Chancellor told MPs the Government could not afford a 2% rise assumed by some departments.
He said: “This is a significant step towards creating a more balanced economy in the regions that does not squeeze out the private sector.”
He also indicated that the state pension age would now go up from 66 to 67 as soon as 2026 – saving £59bn in the long term.
He revealed the OBR is predicting unemployment will rise from 8.1% this year to 8.7% next year, before falling to 6.2% by 2016.
In attempts to further boost growth, there will be a £40bn “credit easing” to get money into small businesses and a £5bn fund for infrastructure projects.
Families will be given a new “right-to-buy” with discounts of up to 50% on council houses, with the money raised paying for new affordable homes.
Energy-intensive industries will also receive £250m in support. Mr Osborne said: “We are not going to save the planet by shutting down our steel mills, aluminium smelters and paper manufacturers – all we would be doing is exporting jobs.”
A further £1.2bn of infrastructure spending will go to schools, including the creation of 100 new free schools, many of which will specialise in maths teaching.
And the bank levy is being hiked to 0.088% to raise £2.5bn a year.
Mr Osborne said: “All that we are doing today – sticking to our deficit plan to keep interest rates as low as possible; policing the supply of credit to pass those low rates on to families and businesses; rebalancing our economy with an active enterprise policy and renewed infrastructure; help with the cost of fuel duty and rail fares – all this takes Britain in the right direction…
“People know the promises of quick fixes and more spending this country can’t afford at times like this are the policies of a quack doctor selling a miracle cure.
“We do not offer that today. What we offer is a Government with a plan to keep interest rates low, a Government determined to support businesses and jobs, a Government committed to take Britain safely through the storm. Leadership for tough times, that’s what we offer.”
Read more on the Autumn Statement: