George Osborne was forced to cave in to pressure from the Labour Party and announce a cap on the costs of controversial payday loans yesterday.

The Chancellor said the limit, which will cover fees on the lending as well as interest, would help prevent vulnerable consumers being exploited.

Activists welcomed the decision but said more needed to be done.

The government will bring in powers to impose the restriction through an amendment to the Banking Reform Bill, but the level of the cap will be set by the new Financial Conduct Authority (FCA).

It comes after Labour leader Ed Miliband complained earlier this month that payday loan firms such as Wonga were "running riot through our communities."

Ministers had resisted the idea of a cap, warning that less credit-worthy individuals could end up being forced into the arms of loan sharks.

Mr Osborne told ITV's Daybreak: "We are going to introduce a cap on the cost of these loans and I mean a cap on all the different elements brought together because it is not just the interest charge, it's also the arrangement fees and the like - to protect people who take out these loans, to make sure they are not being exploited."

Lib Dem Business Minister Jo Swinson warned that interest rate caps to tackle payday lenders could result in "unintended consequences."

She said rate-capping could mean people who might be able to afford to pay back loans finding they cannot get credit and possibly turning to "unsavoury alternatives."

Executive director Richard Lloyd of consumer advocacy group Which? warned that legitimate lenders of all colours needed to brought into line, not just those in the headlines.

He said: "The government and the FCA must clamp down on irresponsible lending and excessive fees across the board, whoever the lender."

Unite general secretary Len McCluskey said the root cause of payday lenders needed to be dealt with as well.

He said: "This belated U-turn is welcome but will be cold comfort for those struggling to make ends meet.

"Questions still remain about what level interest rates will be capped at and when.

"Urgent action is needed to not just tackle payday lenders but the cost of living crisis that had fuelled their rise."