Angela Merkel yesterday pledged to review a recently introduced unemployment benefit that has cost billions of euros and is threatening to torpedo Germany's efforts to tackle its vast budget deficit.

Describing the country's fiscal situation as "desolate", the chancellor said the 18-month old benefit, known as Hartz IV, had created "the wrong incentives", discouraging almost 1m working recipients of the benefit from working longer hours because they would loseeligibility.