The so-called holdback mechanism, under which ministers reserved the right to keep back up to Pounds 50 million (2 per cent) of the further education sector’s global grant, will not apply next year, Education and Employment Secretary Gillian Shephard has decided.

The move has been welcomed by the unions and employers alike. NATFHE general secretary John Akker said the “sword of Damocles” hanging over colleges had been lifted. Roger Ward, chief executive of the Colleges’ Employers’ Forum, said the mechanism was now “redundant”.

The holdback threat, in place for two years, gave the Government a lever on colleges to push through more flexible contracts in place of the local education authority conditions set out in the Silver Book.

Junior education and employment minister James Paice, writing to colleges this week in the wake of the Budget settlement, said the mechanism was being abandoned as a reward for progress on introducing new contracts.

But the concession is unlikely to mollify colleges in the light of a brutal Budget settlement which demands efficiency savings of up to 7.3 per cent on the sector each year until the end of the century.

Mr Paice also issued a warning that holdback, which left the Government free to claw cash back from college budgets, would be reimposed if colleges “adopt restrictive practices that threaten the sector’s future”.

The Secretary of State’s decision on holdback comes after the CEF requested that the mechanism be dropped in recognition of efficiency gains in the sector. A CEF survey published this week - 211 colleges responded - suggests 70 per cent of lecturers have signed new flexible contracts and that those which vary from the CEF model had made “acceptable” modest alterations.

Mr Akker contests this, insisting that almost half the colleges have deals negotiated with NATFHE.

To the fury of many lecturers, it was CEF chief executive Roger Ward who advised civil servants to bring in the penalties in the first place. The holdback had already yielded success in a bid to break a contracts dispute in higher education. Some college heads are suspicious of Mr Ward’s motives in getting the holdback scrapped at a time of sensitive merger talks between the CEF and the Association for Colleges.

The holdback was drafted when Tim Boswell was further and higher education minister. He had gained respect across the FE sector as a no-nonsense “friend” of colleges. Mr Paice has so far shown himself to be more distant and abrasive, to the extent that he was heckled at the annual conference of the Association for Sixth Form Colleges last week for what was seen as insensitivity and a lack of understanding.

There were fears that he would use the holdback for far more draconian measures such as the imposition of performance-related pay.

Two years ago a few colleges caused resentment among the majority when they agreed deals with NATFHE which led ministers to impose holdback penalties to stop similar “soft” deals being agreed more widely.

Mr Paice praised the CEF for its work promoting performance-related pay in colleges. PRP remains a key element of Government public-sector pay policy, which this year again emphasised the need to fund salary increases through efficiency gains or cuts.

He also welcomed the increasing use of agency lecturers for part-time work - another development which has angered many part-timers, who claim their conditions have worsened as a result of the switch.