UK faces fresh spending cuts in Budget

George Osborne with CNBC's Julia Chatterley in Davos, Switzerland in January 2016.

Britain is facing a new round of spending cuts in next month's Budget, George Osborne has warned, following "new figures that show the economy is smaller than we thought".

Speaking ahead of the G20 finance ministers meeting in Shanghai, the UK chancellor said Britain "may need to undertake further reductions in spending because this country can only afford what it can afford". His words will send shivers down the spines of senior civil servants who are already struggling to find additional savings after years of deep cuts.

Less than a month before the Budget, Mr Osborne will have a good idea of the shape of the UK's economic forecasts. His unusually explicit comments suggest they do not look good.

The chancellor told the BBC that the government would use the annual financial set piece to "look at public expenditure again" and that his economic principles were that "we must live within our means". He gave no sense of what scale of additional cuts he was anticipating.

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On existing plans, public spending on services other than health is set to reach its lowest level as a proportion of national income since 1948-49, at a time when Britain's population is expanding and ageing.

Whereas Mr Osborne was able to use an unexpected forecasting windfall to scrap plans for highly controversial cuts to tax credits in the Autumn Statement, in recent months the economic news has been running against the chancellor.

This month the Bank of England downgraded its inflation, growth and wage forecasts and the likelihood is the Office for Budgetary Responsibility will have to do the same. It is probable the chancellor has already seen at least the first iteration of the OBR's forecast.

Revisions to official data just before Christmas showed that nominal GDP — which measures the value of the economy without adjusting for the impact of inflation — fell to its lowest rate since 2009.

Although Mr Osborne sought to cast the blame firmly on global economic factors, much of the weakness in the government finances is due to tax receipts being persistently weaker than forecast over a number of years. Slower-than-expected wage growth, in particular, has meant income tax receipts have been a continual disappointment.

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