A number of civilian staff will be axed and major spending contracts will have to be scaled back, the Chancellor said, although military personnel are now safe after thousands were laid off last week.
However, at the same time as he claimed that the UK economy was now “out of intensive care”, Mr Osborne made it clear there would be more cuts to come, refusing to guarantee the future of pensioner benefits such as winter fuel payments beyond the next election.
In a sign of a growing cross-party consensus on spending, Labour leader Ed Miliband warned that his party must face up to the “hard reality” that it would not be able to reverse spending cuts scheduled by the coalition for 2015-16.
In an interview yesterday, the Chancellor elaborated on his medical metaphor, saying the UK economy was improving, but there “certainly is the chance for a relapse” if measures to bring down the deficit were abandoned.
Mr Osborne will on Wednesday set out plans to slice another £11.5 billion from UK spending in 2015-16, which covers the period after the next general election in May 2015.
It will also result in the Scottish Government budget being reduced and finance secretary John Swinney said yesterday that the “persistent cuts” were putting the country’s employment revival at risk.
Mr Osborne revealed yesterday that he had reached a deal with Defence Secretary Philip Hammond on a fresh round of cuts. Justice, energy and communities had already agreed to “significant savings”, but schools and foreign aid would be protected from cuts.
Talks were still continuing to reach agreement with other ministries, including Vince Cable’s Business Department, and Mr Osborne acknowledged there were still arguments about the “small details” with his Liberal Democrat Cabinet colleague.
He also confirmed plans to use fines from the banks to help support the welfare of troops and veterans.
The Chancellor said: “I have settled the defence department, which people thought was going to be one of the biggest and most difficult challenges.
“It’s going to involve some tough choices. The civilian headcount is going to have to reduce in our defence department, we are going to have to renegotiate, with some of our big suppliers, the contracts.
“But there will not be a reduction in our military capability, we are not going to reduce the number of our sailors, soldiers and airmen. In fact we are going to be able to spend some more money on things like cyber, which is the new frontier in defence.”
Redundancy letters went out to up to 5,000 UK military personnel last week, in the third and biggest round of army job cuts following the 2010 review. Mr Osborne said yesterday spending would also go up by about £10 million a year on good causes to help soldiers who have returned from Afghanistan and Iraq with horrific injuries.
“We are using the money we have taken off bankers involved in the Libor scandal. So the people who demonstrated the very worst of British values in the Libor scandal, in the City, are now supporting those who have demonstrated the very best of British values – our soldiers, who gave so much to defend the country.”
Labour has said it would take winter fuel payments from the richest pensioners, but Prime Minister David Cameron made a pledge at the general election to protect the handouts.
Mr Osborne said yesterday that applied to this parliament, without committing to funding pensioner benefits beyond the 2015 election, saying: “We have got to look at how we can afford them.”
He added: “We made a very clear promise about this parliament and the winter fuel payment. We believe in keeping our promises to the British people.
“When it comes to pensions and pensioner benefits, our society is getting older, we are going to be spending more on our older people, I want to make sure that’s sustainable.” He added: “All those pensioner benefits, not the basic state pension, all those other pensioner benefits of course we have got to look at how we can afford them.
“I do think the simplest thing we can do is to increase the pension age as we have done and set out those increases to 66 and 67.
“I don’t want pensioners to be impoverished, I want pensioners to have a standard of living that reflects the fact they have worked hard all their lives.
“I would focus instead on the fact that we are living longer.”
He said that after 2015, “we will have to consider the promises we make for the next parliament but I think having looked at the way we have behaved in this parliament, not only have we kept our promises but we have made sure that this country can afford the budget”.
Mr Miliband told Labour activists that if the party won the next election, it would be in “tough” economic times.
“Our starting point for 2015-16 is that we won’t be able to reverse the cuts in day-to-day current spending unless it is fully funded from savings elsewhere or extra revenue, not from more borrowing,” he said.
Labour has already said it would withdraw the winter fuel allowance from the wealthiest pensioners, and would not reverse coalition cuts to child benefit for certain households.
“People will only put their trust in us if we show we are credible,” Mr Miliband said.
Shadow chancellor Ed Balls indicated a Labour government might borrow more to fund major building projects. He said he would change current “day-to-day” expenditure without spending more than the Chancellor’s plans, but if there was a case to invest in capital projects such as roads, Labour might increase borrowing.
Mr Swinney said he expected the Scottish budget to face cuts when Mr Osborne sets out his plans in the spending review “We know growth will not happen in the face of persistent cuts,” Mr Swinney said.
“It is investment in infrastructure, in young people and in supporting living standards that can move the economy in the right direction. Westminster is doing the opposite and that is putting Scotland’s progress at risk.” He said cuts to household incomes were “turning off the tap” of economic investment.
“With the powers of independence we could protect public services, promote those growth sectors where we have comparative advantage and encourage greater cohesion in society, which we know is a driver of economic growth,” he said.