UPDATE 2-Britain's health service "facing funding crisis"

* Report says National Health Service's survival threatened

* Election challenge to main parties

* Warning of "across the board" cuts, longer waiting times

* Cap on budget for new drugs may be necessary

(Recasts with political reaction)

By Kate Kelland

LONDON, June 10 (Reuters) - Britain's state health service is facing the biggest financial squeeze in its 60-year history, a report said on Wednesday, posing a stark challenge for the next government.

The costs of fighting recession and rescuing stricken banks will send Britain's budget's deficit soaring to 12 percent of GDP this year and the national debt is ballooning, but no political party has yet spelt out the impact on public services. A report by managers of the National Health Service (NHS) said recession and rising costs will squeeze its budget by 15 billion pounds ($25 billion) in the five years from 2011, leading to "across the board" cuts in jobs and medical services and a possible cap on spending on new drugs.

The report said the very existence of the NHS -- which with more than 1.5 million staff is Europe's biggest employer -- could be under threat.

"History suggests that failing to deal with the spending squeeze will lead to problems large enough to call the whole NHS into question," it said. "We cannot assume it will survive."

The quality and funding of the health service are always a top priority for British voters. Prime Minister Gordon Brown's Labour government, which badly trails the Conservatives in opinion polls, must call the next election by June 2010.

CUTS 'PREMATURE'

Health Secretary Andy Burnham admitted the NHS faced a "challenge" in the next decade but said talk of services or jobs being cut was "completely premature".

Andrew Lansley, health spokesman for the opposition Conservatives, said his party was "committed to real-terms growth" in NHS budgets, but insisted the health service must cut waste and bureaucracy.

Labour said Lansley's comments pointed to Conservative spending cuts of 10 percent in other departments after 2011 - a charge the opposition denied.

The debate over spending cuts and taxation will dominate campaigning for the election.

"In just under two years, the NHS will face the most severe constriction ever in its finances," the NHS Confederation's report said. It said the two years leading up to 2011 would be "tough but manageable".

The report said funding shortages could lead to job cuts, longer patient waiting lists and falling standards.

It added a cap on the budget for new drugs may have to be considered, and suggested looking at a "total resource ceiling" for the National Institute for Health and Clinical Excellence, which assesses the cost-effectiveness of new treatments.

The NHS was launched in 1948 as a health service promising cradle-to-grave healthcare, free at the point of delivery. It now deals with eight patients every second.

According to the government's Department of Health, the NHS budget for 2009/10 is almost 103 billion pounds ($168.8 billion), a 7.5 percent real-term increase on the previous year.

The report noted finance minister Alistair Darling's projections for public spending to grow by 0.7 percent in coming years, but said this was likely to be swallowed up by increases in debt interest payments and welfare benefits.

The result could be a real-terms reduction of 2.3 percent in resources available for other government departments, such as health. The report said there was scope to save money, and although not easy, savings were crucial to the NHS' survival. (Additional reporting by Ben Hirschler, editing by Mark Trevelyan)