Theresa May and Chancellor Philip Hammond must lift the public sector pay cap as it is unsustainable in the long-term but will have to cut spending or hike taxes to pay for it, a former top Treasury official has said.
Lord Macpherson of Earl's Court, who spent a decade as permanent secretary to the Treasury until 2016, said a failure to properly cost any lifting of the 1% cap would leave the deficit unacceptably high.
His comments came amid mounting speculation that the Prime Minister was ready to end the long-standing cap on pay rises in the public sector after a disastrous general election which saw the Tories lose their House of Commons majority.
Earlier this week, Defence Secretary Sir Michael Fallon said the Government fully understood that public sector workers have taken their "share of the pain" of deficit reduction and signalled that the Chancellor was looking at the issue.
The Institute for Fiscal Studies has said if public sector pay were to rise in line with inflation for the next three or four years it would cost the public purse £6 billion to £7 billion more than continuing with the cap.
Commenting on the speculation, Lord Macpherson told BBC Radio 4's Westminster Hour: "Generally pay caps aren't sustainable in the long term.
"So the Government does need to find a way of getting off this policy.
"On the other hand, it does cost money. And what I would be asking the Prime Minister and indeed asking Mr Hammond is, well, if you're going to relax policy in this area, how are you going to pay for it?
"What tax are you going to raise, what spending are you going to cut? Or are you just going to let the deficit remain at an unacceptably high level?"
The Treasury is due to send out letters within weeks setting out the remit for public sector pay review bodies for next year's pay round and Mr Hammond is under pressure to allow them greater flexibility to recommend more generous rises.
One plan reportedly under consideration could see the lowest-paid public sector workers, along with groups with the biggest retention problems such as nurses and senior civil servants, granted a pay rise at least in line with inflation next April, with restraint for others lifted in 2019.
Mr Hammond has refused to be drawn on the reports, insisting the Government must balance pay rises against increased costs.