By Andy Bruce and William Schomberg
LONDON (Reuters) - British finance minister Philip Hammond said on Wednesday he could free billions of pounds for extra public spending or tax cuts, as long as parliament resolves its Brexit impasse.
Hammond told lawmakers he could relax his grip on the public finances if they spared Britain the shock of leaving the world's biggest trading bloc without an agreement.
"I hoped we would do that last night, but I am confident that we, as a House, will do it over the coming weeks," he said.
On Tuesday, parliament rejected Prime Minister Theresa May's proposed Brexit plan for a second time, little more than two weeks before the scheduled date of departure from the EU.
"Leaving with no deal would mean significant disruption in the short and medium term and a smaller, less prosperous economy in the long term, than if we leave with a deal," Hammond told parliament, warning of higher unemployment and prices and lower wages under a no-deal Brexit.
"That is not what the British people voted for in June 2016," he said.
Lawmakers were expected to vote later on Wednesday against a leaving the European Union without a transition deal, then vote on Thursday on seeking a delay to Britain's departure, currently scheduled for March 29.
New half-yearly fiscal forecasts showed that Britain's public finances were in better shape than in October, when Hammond gave his full, annual budget statement, even against the backdrop of a weaker outlook for the country's economy.
Strong income tax receipts, reflecting Britain's lowest unemployment rate since the 1970s despite the economic slowdown, lay behind the improved outlook for the budget.
Hammond said he now had 26.6 billion pounds of fiscal "headroom" that he has earmarked as a potential war chest for helping Britain's economy -- for example, via extra spending or tax cuts -- up from a previous estimate of 15.4 billion pounds.
He repeated his forecast that there would be a Brexit deal "dividend" as companies regained confidence and he could choose between increased spending on public services, capital investment and keeping taxes low while also bringing down debt.
However, Britain's independent budget forecasters said almost half of Hammond's fiscal headroom might be lost, depending on how official statisticians treat student loans in the public accounts.
Hammond also announced an extra 100 million pounds in funding for police to tackle rising knife crime after a spate of high-profile murders.
In his full budget statement in October, Hammond also held out the prospect of higher spending or tax cuts if parliament backed the government's Brexit plan. Britain's parliament rejected that plan in January and again on Tuesday.
Hammond announced official forecasts showing growth would be weaker this year than expected in October, but Britain's budget deficit would be smaller. [nL8N20Z5V8][nL8N20Z5SC]
The forecasts were produced by the Office for Budget Responsibility, Britain's budget watchdog, and assumed that Britain would leave the EU with a deal.