Osborne insists Plan B will mean higher rates

The Chancellor, George Osborne, told the Treasury Select Committee yesterday that any let-up in his plan to reduce the fiscal deficit would result in an almost immediate rise in borrowing costs and mortgage bills.

Mr Osborne also defended the Governor of the Bank of England, Mervyn King, from accusations that he had grown too political; refused to rule out petrol at over £1.50 a litre; and also took the opportunity to confirm that he was prepared to further review Private Finance Initiative projects.

Many commentators have suggested that there is a tacit deal between the Treasury and the Bank, whereby the Government cuts the deficit while the Bank supports the economy with ultra-low interest rates. Mr Osborne told MPs: "I think if we were to loosen fiscal policy now... there would be a monetary response almost immediately with a tightening of monetary policy and an increase in interest rates."

The Chancellor highlighted two key risks to his plans and to the wider economy: "The rising commodity prices have clearly had an impact and, of course, in the UK [were] exacerbated by the very sharp devaluation, which is part of the rebalancing of the British economy but nevertheless has increased the inflationary pressure. Then you have the European sovereign debt problems, which Portugal is the current live example of, and we have to negotiate our way between those twin threats."

On the Bank's role, Mr Osborne said that Mr King "is very careful about how he expresses his opinion" though "robust" in his views.

Pressed by the Conservative member Jessie Norman on revisiting PFI contracts, Mr Osborne said that "some contractors have done pretty well" out of the arrangements and agreed to take what Mr Norman called "an unflinching look at possible sources of value" for taxpayers.

The shadow Chancellor, Ed Balls, said: "The result of slower growth and lost jobs is that government borrowing will actually be £46bn higher than planned.

"This doesn't make economic sense and underlines Vince Cable's warning a year ago that cuts without growth won't get the deficit down."