Move could forge closer ties between two trading powers as they face slower growth at home and competition from China

President Barack Obama unveiled plans for a new free trade agreement between and the US and Europe in his annual state of the union speech.

Announcing new talks on a "comprehensive transatlantic trade and investment partnership", Obama told Congress: "Trade that is free and fair across the Atlantic supports millions of good-paying American jobs."

Obama gave no further details but the talks with the European Union, which follow a year of exploratory discussions, will center on phasing out tariffs and reduce regulatory barriers in a move that would create closer ties between the two trading powers at a time when they face slower growth at home and increasing competition from China.

The president concentrated most of his speech on domestic economy – concentrating on the overspill from the fiscal cliff budget crisis at the end of 2012. The argument left the US facing deep cuts to defense and social programmes next month – known as sequestration – as Washington tries to tackle its $16tn in debt.

Obama called for cross-party support to head off those cuts and find a compromise. "The greatest nation on Earth cannot keep conducting its business by drifting from one manufactured crisis to the next," he said.

"I realise that tax reform and entitlement reform won't be easy. The politics will be hard for both sides. None of us will get 100% of what we want. But the alternative will cost us jobs, hurt our economy, and visit hardship on millions of hardworking Americans," he said.

The president set out proposals he believes will help the US recovery and called on Congress to pass legislation he has already proposed to help homeowners and the job market.

Obama called for the federal minimum wage to be raised to $9 an hour, currently $7.25, and to tie it to the cost of living.

Obama announced the creation of three new innovation centres meant to encourage growth in manufacturing within the US. The first innovation institute opened in Youngstown, Ohio, last year.

He also unveiled a "Fix-It-First" programme to put people to work on urgent repairs, "like the nearly 70,000 structurally deficient bridges across the country".

The US economy is on the mend, Obama said. "We buy more American cars than we have in five years, and less foreign oil than we have in 20. Our housing market is healing, our stock market is rebounding, and consumers, patients, and homeowners enjoy stronger protections than ever before," he said.

"But we gather here knowing that there are millions of Americans whose hard work and dedication have not yet been rewarded. Our economy is adding jobs – but too many people still can't find full-time employment. Corporate profits have rocketed to all-time highs – but for more than a decade, wages and incomes have barely budged.

"It is our generation's task, then, to reignite the true engine of America's economic growth – a rising, thriving middle class," he said.

He said the looming sequester would jeopardise military readiness, devastate education, energy and medical research and "cost us hundreds of thousands of jobs".

Republicans have suggested stopping the defence cuts and making bigger cuts to education and job training. "But we can't ask senior citizens and working families to shoulder the entire burden of deficit reduction while asking nothing more from the wealthiest and most powerful," he said.

Obama said the US's massive Medicare national insurance programme was in need of reform. The president said he would enact reforms to reduce spending to levels suggested by the bipartisan Simpson-Bowles commission. Obama said he would cut taxpayer subsidies to drug companies and change the way government pays for Medicare "because our medical bills shouldn't be based on the number of tests ordered or days spent in the hospital – they should be based on the quality of care that our seniors receive".

He said he was open to suggestions for more reforms but added. "Our government shouldn't make promises we cannot keep – but we must keep the promises we've already made."

Aside from the European venture Obama's speech contained no major new economic policies.

Richard Sotell, president of investment adviser Kraematon Group, said he was disappointed that a "grand bargain" to tackle US debts and spending now appeared to be off the table.

"The real issue is we are on a completely unsustainable course. Medicare and Medicaid will totally crowd out every aspect of the budget unless we deal with it. And yet the government continues to kick the can down the road."