In delivering his Autumn Statement, earlier this afternooon, Osborne said: "For some workforces, the two year pay freeze will be coming to an end next spring, for most during 2013.
"In the current circumstance the country cannot afford the 2% rise assumed by some government departments thereafter.
"So instead, we will set public sector pay awards at an average of 1% for each of the two years after the pay freeze ends.
"Many are helped by pay progression - the annual increases in salary grades that many people are entitled to, even when pay is frozen.
"It is one of the reasons why public sector pay has risen at twice the rate of private sector pay over the last four years.
"So while I accept that a 1% average rise is tough; it is also fair to those who work to pay the taxes that will fund it.
"I can also announce that we are asking the independent Pay Review Bodies to consider how public sector pay can be made more responsive to local labour markets - and we will ask them to report back by July next year."
He added this will save more than £1 billion in current spending by 2014-15 and "is also fair to both taxpayers and public servants".
Turning to public sector pension reform, the chancellor added:"I would once again ask the unions why they are damaging our economy at a time like this - and putting jobs at risk.
"Call off the strikes tomorrow, come back to the table, complete the negotiations - and let's agree generous pensions that are affordable to the taxpayer"
Christopher Johnson, head of Mercer's Human Capital business, said: "Easing the public sector pay freeze by capping pay increases at 1% should be welcomed by public sector employees. This increase, plus incremental progression, will ensure that public sector average earnings growth continues to outstrip private sector earnings growth.
"Our view is that it is right to restrain public sector pay. There is both an issue of affordability and an urgent case for pay reform. While the Government's short-term actions address short-term affordability pressures, the Government must address the fundamental long-term issues about how much public servants should be paid and how public sector pay can better encourage a culture of performance.
"We are also very pleased to see the Government's decision to invite public pay review bodies to review local pay for the public sector, although it is unlikely to be implemented any time soon. The impact of the current practice of using national pay scale means that in some local markets outside London and the South East, the public sector drives the local jobs market making it difficult for private sector employers to compete for talent. However, the problem needs to be carefully addressed as the localising of public sector pay has an impact on the local economy."