Osborne says spending cuts won't derail recovery

LONDON (Reuters) - Chancellor George Osborne on Tuesday hit back at accusations that spending cuts would plunge the economy back into recession, saying deficit reduction was the only way to navigate a choppy recovery.

Osborne pointed to the fall in long-term borrowing costs in recent months as evidence that investor confidence in Britain had recovered, and said the biggest risk to recovery -- a spike in long-term gilt yields -- had been avoided.

"There is a confidence out there that was not present a few months ago and that is having a huge stimulating effect, a monetary stimulus, for businesses and families," he said.

Osborne produced the harshest budget in a generation in June, promising to slash spending and hike taxes in order to reduce a record budget deficit of 11 percent of GDP to almost nothing in five years.

Government departments have been told to cut their budgets by 25 to 40 percent over the next four years.

Most of the pain will not be felt until next year but business and consumer sentiment indicators have already turned down amid warnings of thousands of public sector job cuts.

The Bank of England last week cut its forecast for economic growth over the next two years, partly in response to the planned fiscal tightening.

LESSER OF TWO EVILS

Osborne agreed with the Bank's assessment that the recovery was likely to be choppy, but said the bigger risk would have been to ignore the risks posed by a ballooning deficit.

He laid the blame at the feet of the previous Labour administration.

"The gamble would have been not to act, to put Britain's reputation at risk, and to leave the stability of the economy to the vagaries of the bond market, assuming investors around the world would continue to tolerate the largest budget deficit in the G20," Osborne said.

He said there was reason to be "cautiously optimistic" about Britain's economic situation, but acknowledged that inflation was proving more resilient than expected.

Data earlier on Tuesday showed inflation eased only a fraction to 3.1 percent in July, still more than a percentage point above target.

The Treasury will publish the breakdown of expenditure cuts announced in the June budget in a spending review on October 20.

Osborne argued the review was not just about cuts for cuts' sake but rather shaping the economy with a pro-growth agenda, and empowering people by decentralising power.

He said the public sector would have to be reformed so it provided value for money. Defence and security spending also had to be looked at again to shape Britain's future role in the world.

"We will follow a ruthless approach to waste, inefficiency and bureaucracy in government. And if that means bringing in external expertise, we will do that," he said.

"It is not about how much the government spends but about what the government actually does with the money."

(Additional reporting by Matt Falloon, Christina Fincher and Adrian Croft) (Reporting by Sumeet Desai; Editing by Susan Fenton)