Last year Osborne was outvoted 26-1 on the issue which proposed to cap bonuses to 100 percent of a banker’s annual salary, or to 200 percent if shareholders approve.

Syed Kamall, leader of Tory MEPs in Brussels said the legal advice would drive “a further wedge between Britain and the EU.”

Dr Kamall added “Part of the advice says that a limit on bonuses will not limit overall pay – and that is exactly the problem.  Banks will still find ways of rewarding talented and hardworking staff in a global employment marketplace, but if bonuses are capped that will mean increasing salaries.  That will lead to less alignment between performance and pay, meaning bankers would be paid well even if they performed badly.

“I see this as a gross interference in the way a key sector of the British economy organises its staff remuneration. If the advice is adopted it could drive another wedge between Britain and the EU and further offend public opinion over Europe.”

And UKIP MEP Steven Woolfe slammed Cameron’s reform agenda after advice which, in the vast majority of cases, the court will ultimately adopt be adopted as EU law.

“Today’s ruling shows just how dead in the water Cameron’s reform attempts are,” said the City barrister.

“Osborne has made it a personal mission to overturn this cap, yet one simple decision made in a foreign court has completely undermined his attempts”.

He said that he feared the ruling would mean companies leaving the City of London, saying: “Companies will be under pressure from their own investors and staff to relocate the businesses to bypass this legislation in order to hire and retain the brightest and the best workers.”

The Financial Service Industry provides billions in tax revenues for the Treasury, helping to fund the Armed Forces and Health service.

The Treasury said it was considering its options.

“The Government notes the Advocate General of the European Court of Justice’s Opinion on our legal challenge against the EU ‘bonus cap’. We are considering the Opinion and its implications in detail,” a spokesman told The Telegraph.

Mr Jääskinen, Advocate General at the European Court of Justice, dismissed all six arguments the UK had made in its appeal.