John Pienaar reports

Chancellor Gordon Brown has slapped down union demands for 3% annual increases in public spending.

In a robust speech to businessmen in London, he insisted the government would stick firmly to the Tories' spending limits for the rest of the parliament.

And he signalled he intended to have a budget surplus every year and would only borrow to invest.

The move, as the government's crucial Comprehensive Spending Review moves into its final phase, puts Labour and the unions at loggerheads and could prove a fundamental test of strength.

Many union leaders believe they did their bit to get Labour elected and it is now time for the government to start repaying the debt with better public services and pay increases.

No prisoners

But the chancellor was taking no prisoners in his speech, which came just hours before he was due to meet a union delegation in Downing Street.

"Those who said that we would fail to show the necessary discipline in public spending have been proved wrong.

"And discipline is not for one or two years, but must be locked in and continuous so that we can build the platform of stability upon which prosperity depends.

"This is the way to ensure that Britain will have sustainable public finances over the economic cycle," he said.

John Monks demanding spending increases.

But TUC general secretary John Monks led the backlash, saying the government had to make a "fundamental choice".

"If it does not increase public spending then we face growing inequality and poverty and more social exclusion."

He told BBC Radio 4's Today programme: "The chancellor is in a sense getting to a stage where he puts behind him the commitment to Tory spending limits for the first two years of the government.

"What he decides in the Comprehensive Spending Review will set the tone for the whole Parliament. It's a key decision.

"We are looking when we see the chancellor, to urge on him the need to keep public spending up with economic growth - and long term growth is 3% a year."

Chancellor: spending plans spark union anger

Unison leader Rodney Bickerstaffe hammered home the message, declaring it was "totally unnecessary" to extend the Tory straitjacket on public spending.

"Public sector workers and those who depend on their services will feel angry and demoralised that their years of austerity are to be extended unnecessarily and unfairly.

"Surplus cash should be used to strengthen our public services. It is no use having a surplus if we still have long hospital waiting lists, large class sizes and teachers, nurses and doctors voting with their feet by leaving their service."

But the chancellor's message was clear and was deliberately aimed at the unions to prove that the government is not about to cave in to industrial muscle.

Golden rule

He said he was determined to stick to his "golden rule", "to ensure that we not only balance the current budget over the economic cycle but that we achieve current surpluses every year for the rest of the Parliament.

"In other words, current spending will be more than covered by current revenues and we will no longer borrow to consume.

"And secondly, although the CBI has rightly pointed out that Britain's economic infrastructure badly needs rebuilding, meeting our fiscal rules also means that we will set the debt-GDP ratio at a prudent and sensible level.

"And in the outcome of our spending review, we will set the figure for the whole Parliament."

Monks: 3% demand

The clash comes as the spending review enters its final stages with all Whitehall departments expected to face demands for economies.

And it has marked out a battle ground between the government and the unions who believe it is time Labour started putting its money where its mouth is.

They believe the chancellor is storing up a surplus of billions of pounds over the course of the parliament and should use it to improve public services.

They are aleady on collision course with the government over the minimum wage, which they want pitched higher than the likely rate of £3.60 an hour. And the latest clash is certain to strain even further the relations between them.

The chancellor has been eager to damp down speculation that he will use part of an alleged £50bn surplus to pour money into health and education - areas where the Tories claim Labour is failing to meet its election pledges.