Sunak announces record peacetime borrowing to combat historic downturn

Rishi Sunak has said the government will borrow a peacetime record of almost £400bn this year as it seeks to combat the worst recession in more than 300 years.

The chancellor said the UK faced an “economic emergency” warranting a cut in international aid and a public sector pay freeze for millions, with an exemption for NHS staff and workers earning less than £24,000 per year. However, he insisted there would be no turning back from the government’s levelling-up agenda, announcing a £4bn fund to pay for local projects such as bypasses, libraries and station improvements.

Related: UK politics live: Rishi Sunak freezes public sector pay except for NHS and cuts overseas aid

Sunak’s “levelling up” fund, which must be spent over the course of the parliament, will be a welcome boost to Conservative MPs particularly in “red wall” seats where MPs have been warning the chancellor they must see tangible improvements to their high streets and infrastructure to keep hold of the newly Tory seats.

Though some red wall MPs have voiced approval at the cut in spending on foreign aid, Sunak faced a furious backlash from senior Tories committed to the 0.7% target who have vowed to block the cut.

Setting out the government’s spending plans for 2021-22 as the second wave of the Covid-19 pandemic threatens to push Britain’s economy into a double-dip recession, the chancellor said the one-year spending review would “deliver stronger public services and a once-in-a-generation investment in infrastructure”.

Forecasts from the government’s tax and spending watchdog, the Office for Budget Responsibility (OBR), updated to take account of the second lockdown in England and tougher restrictions in Scotland, Wales and Northern Ireland, show the economy will drop by 11.3% this year and take until the end of 2022 to recover to pre-pandemic levels.

Unemployment will rise to 7.5% next year – less than originally feared because of the Treasury’s furlough scheme and support for the self-employed – before falling to 4.4% in 2024. Nonetheless, it will mean 2.6 million people unemployed, as furlough comes to an end and companies struggle to stay afloat or retain some staff.

Setting out the government’s plans to find some savings while increasing public spending overall next year by 3.8% – the fastest rate in 15 years – Sunak said he could not justify maintaining the international aid budget at its current levels “at a time of unprecedented crisis”. He said a significant cut from 0.7% of GDP to 0.5% would be deployed to save £4bn next year. Spending would then return to the internationally agreed level “when the fiscal situation allows”.

He said the freeze on public sector pay would not apply to millions of workers, including NHS staff and public servants earning less than £24,000, who will get a pay rise of £250.

Anneliese Dodds, the shadow chancellor, said cuts to public sector pay would hit the economy and flew in the face of public support. “Earlier this year the chancellor stood on his doorstep and clapped for key workers. Today, his government institutes a pay freeze for many of them.

“This takes a sledgehammer to consumer confidence. Firefighters, police officers and teachers will know their spending power is going down, so they will spend less in our small businesses and on our high streets. They will spend less in our private sector,.”

Trade union leaders warned the chancellor was delivering a kick in the teeth to workers on the frontline of the government’s pandemic response. However, Sunak said the renewed pay freeze – reminiscent of the austerity drive imposed by George Osborne after the 2008 financial crisis – was vital to ensure fairness between the public and private sectors.

The chancellor said private sector wages had fallen in the six months to September by 1% compared with a year ago, while public sector pay had risen by almost 4%, and that public servants’ jobs were under less threat during the crisis.

The cut to international aid sparked a serious backlash among Conservatives responding to the chancellor’s statement. The Foreign Office minister Lady Sugg has submitted her resignation over the cut and the Tory grandees Sir Peter Bottomley, David Davis and Andrew Mitchell said they would work with any opposition efforts to oppose it.

Others who voiced anger and distress at the cut included the Tory chairs of the foreign and defence select committee, Tom Tugendhat and Tobias Ellwood.

One influential Tory backbench group, the Northern Research Group led by the former minister Jake Berry, which includes most MPs in the new red wall seats across the north of England, declared the statement a triumph for the group’s lobbying efforts on levelling up.

In a statement, the group said it was thrilled to see “the tearing-up of the Green Book rules that favours investment in London and the south-east” and said it was “clear this northern chancellor has actively engaged with the Northern Research Group’s agenda”.