The new pay agreement, negotiated under arbitration, caps nearly six weeks of talks that started on September 12 in which trade union UFO insisted on a 5 percent pay hike and Lufthansa countered with a 3.5 percent increase.

The airline, which is in the midst of a cost-cutting programme to improve annual earnings by 1.5 billion euros by end of 2014, is struggling to cope with cut-throat competition from no-frills airlines like Ryanair (RYA.I) and Easyjet (EZJ.L) and Gulf carriers.

"The compromise is very painful for Lufthansa," Lufthansa Passenger business board member Peter Gerber told reporters. He said the pay deal meant an additional 33 million euros in costs.

Under the deal, the union, which represents around 18,000 cabin crew, also secured a promise from Lufthansa that there would be no mandatory job cuts until the end of 2014.

Additionally, Lufthansa said it would not outsource cabin crew staff until 2016.

"This is very important particularly during these times when jobs are being cut elsewhere in the company," UFO's Nicoley Baublies said.

Lufthansa said last month it would step-up cost-cuts to counter rising fuel prices and limited growth in its core market, hinting that more job cuts could follow.

The airline has already frozen investments, cut jobs and is combining its loss-making European short-haul unit with its low-cost carrier Germanwings to improve earnings.

Other airlines in Europe are cutting jobs because of high-costs and competitive pressures. Spanish carrier Iberia (ICAG.L) is to cut almost a quarter of its workforce.

UFO, which had been in talks with Lufthansa over pay since middle of last year, staged a series of strikes in early September, forcing Lufthansa to cancel more than 1,000 flights.

The union eventually agreed to arbitration and to a truce, promising not to hold any strikes until the end of November, while mediation was going on.

During the talks, UFO warned that it had enough funds to stage a long strike if the arbitration failed.

Mediator Bert Ruerup, who proposed the pay package , said the deal gave the airline the flexibility to structure a new wage scheme for new hires to make it more competitive, while cabin crew would get a bonus linked to the company's profit margin.

Ruerup said pay would increase in 2013 by nearly 4.6 percent. Lufthansa said the rises over a two-year period to the end of 2014 would average 3.95 percent.

The new pay deal still has to be formally approved by a majority of UFO's members. (Reporting by Peter Maushagen and Marilyn Gerlach; Editing by Hans-Juergen Peters and Jane Merriman)

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