Alistair Darling indicated last night that there would be tax rises or spending cuts after the next election as he pledged to borrow initially to see Britain through the recession but then to rebuild public finances once it is over.

Effectively scrapping the financial rules on debt and investment that have guided economic policy for the past decade, the Chancellor declared that it would be “perverse” to apply them rigidly in today’s difficult conditions.

In a message that was designed to reassure the markets, he said that all governments had to live within their means, “and I will ensure that we do this in the medium term”. He said that people should be in no doubt that the Government “will take the decisions necessary to ensure sustainability in the medium term, and to return borrowing and debt to a sustainable level, once these shocks have worked through, just as we have in the past.

Here, in Europe, in the US – the way we meet our fiscal targets may well change – but the principles underpinning fiscal policy will not.”

He also promised to set out plans in next month’s Pre-Budget Report “to demonstrate our commitment to keeping the public finances on a sustainable path”.

Mr Darling’s definition of “medium term” would take him to about 2010-11. With the next election in the summer of 2010 at the latest, his warnings in the Mais Lecture suggested that both parties will have to go into the campaign admitting tough times ahead, with spending slowing markedly and the prospect of tax rises.

The speech was also an implicit admission that while the Government supports the economy and maintains public investment, the country will be living beyond its means.

As the Chancellor spoke, a member of the Bank of England’s Monetary Policy Committee broke ranks to suggest that it had been too slow in reducing interest rates.

David Blanchflower predicted that more than two million people would be unemployed by Christmas, adding that if rates were not cut aggressively the country faced the prospect of a deep and relatively long-lasting recession. “With hindsight, monetary policy has not been sufficiently forward-looking,” he said.

The Chancellor also gave the clearest hint that he expects the Bank of England to cut interest rates again next week. While he was not changing its remit that gives primacy to controlling inflation, he drew attention to its discretion to support the Government’s “wider economic objectives”.

Mr Darling was more cautious on spending than had been suggested by recent reports. There was no overt suggestion that he would increase the three-year spending totals, although he said it was right to bring forward some planned commitments, such as the September housing package.

Increasing borrowing in a downturn was sensible to support people and businesses, he said, and it was right to put money back into the economy when the private sector could not. He insisted that the Government could do this because it had cut public debt in the past ten years.

“To apply the fiscal rules in a rigid manner today would be perverse,” he said. “We would have to take money out of the economy, exacerbating an already difficult situation.”

George Osborne, the Shadow Chancellor, said of Mr Darling’s speech: “There’s only one thing that is perverse – the Government now has no plan to bring the public finances under control, just a mounting overdraft that will have to be paid off by taxpayers.

“Alistair Darling’s speech achieved the worst of both worlds. He scrapped the fiscal rules that Gordon Brown based his reputation on, but put absolutely nothing in their place.”

Hints for the PBR

— Fiscal rules to be dumped

— Borrowing to soar

— Spending growth to slow

— Growth forecasts will be downgraded

— Rebuilding finances from 2010

— Tighter regulation of banks

— Bank of England’s remit to stay

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