The increase will come into force in October and will push up the minimum wage to �4.50 an hour posing a threat to jobs, according to the British Chambers of Commerce (BCC).

But the UK's biggest public sector union said the increase was not enough and would leave taxpayers to pick up the tab for badly-paying employers.

Patricia Hewitt, the Trade & Industry Secretary, said the October increase was double the rate of average earnings growth and almost three times the rate of inflation.

In addition, Ms Hewitt said that provisionally, there would be a further increase in October 2004, taking the payment to �4.85 an hour.

It is incredible that hundreds of firms have been caught underpaying staff and none has been prosecuted Click here for more on firms dodging the minimum wage

The government also announced that the youth minimum wage rate would rise to �3.80 an hour this year and �4.10 an hour next year.

"We are committed to eradicating poverty pay for all without jeopardising job prospects.

We are confident that this increase will not have a detrimental effect on either employment or the wider economy," Ms Hewitt said.

Mixed reactions

David Frost, director general of the BCC said that the wage was heading "dangerously close" to the �5 mark and would cause further suffering for business.

I defy anyone in government to try to make ends meet at �4.50 an hour David Prentis, Unison union

"By making this decision, the Government is showing business where we stand on its priority list... to survive under this increase, employers will slash costs wherever they can, including possibly a reduction in their workforce," Mr Frost added.

But the government will be cheered that Digby Jones, the director general of employers' group the CBI, described the rise as a "sensible balance between prudence and boldness".

Picking up the tab

The TUC while welcoming the fact that the rise was above inflation cautioned that low paid workers would be disappointed that the Low Pay Commission had not raised the wage to �5 per hour - a step unions have been calling for.

Dave Prentis, general secretary of public sector union Unison said: "I defy anyone in government to try to make ends meet at �4.50 an hour.

Minimum wage rises April 1999 �3.60 (18-21's �3) Oct 2000 �3.70 (18-21's �3.20) Oct 2001 �4.10 (18's-21's �3.50 Oct 2002 �4.20 (18-21's �3.60) Oct 2003 �4.50 (18-21's �3.80) Oct 2004 �4.85 (18-21's �4.10) Source: Low Pay Commission

"The new minimum wage will still leave many people reliant on tax credits and it is the taxpayers who have to pick up the tab for poor-paying employers."

But unions will be heartened by the announcement that the Low Pay Commission is to look at the possible extension of the minimum wage to employees aged between 16 and 18.

At present the full minimum wage applies only to workers over the age of 21.

Employees between the ages of 18 and 21 are entitled to a lower rate and anyone younger has to make do with what their employer pays them.

The TUC believes that introducing a minimum wage of �3 an hour would raise the pay of about 65,000 young workers. Increasing it to �3.60 would deliver a pay rise to about 45% or 290,000 workers.