New general elections will take place on Sunday April 28th, he said.
Pedro Sanchez took power just over eight months ago after he ousted his conservative rival in a dramatic parliamentary no-confidence vote.
At the head of a fragile minority government, the 46-year-old has had to rely on the support of unlikely bedfellows in parliament, including the far-left Podemos party, Basque nationalist lawmakers and – crucially – 17 Catalan separatist MPs.
On Wednesday, these groups joined right-wing lawmakers in rejecting his budget.
They withdrew their backing in protest at separatist leaders being put on trial for their role in a 2017 attempt to break Catalonia from Spain.
Sanchez made a statement at 10 am (0900 GMT) Friday after a special cabinet meeting. In a 20-minute speech he listed his government’s achievements in these last eight and a half months, including job creation and initiatives on environmental and social issues.
He highlighted his government's short track record — from a 22 percent rise in the minimum wage to fighting against energy poverty.
“Between two options — not doing anything and continuing without a budget, or… giving Spaniards their say — I choose the second,” Sanchez told reporters, before announcing the date.
Sanchez blasted “blocking a social budget after seven years of social injustice, austerity, and spending cuts.”
Sanchez's socialists have already adopted a campaign-like tone, accusing Catalan separatists and conservatives of blocking a budget that included many social-spending measures.
“The right wing in this country is trying to put a brake on the social progress of this budget and this government,” Montero said after the budget rejection.
“It's trying to stop this country from moving forward,” she added.
The government has also given the media a document promoting its short track record: from a rise in the minimum wage and restoring universal health care to financing measures against gender-based violence.
“It's the end of an atypical, turbulent term,” said Paloma Roman, politics professor at Madrid's Complutense University.
Sanchez has been savaged by the conservative Popular Party (PP), centre-right Ciudadanos and more recently small, far-right party Vox.
Last Sunday, they called a big protest in Madrid to ask for early elections.
One of their biggest bugbears has been the socialist government's negotiations with Catalonia's separatist executive as Madrid tries to ease tensions with the northeastern region.
While Madrid says it initiated talks to try and find a way out of an ongoing crisis, the opposition has accused it of yielding to separatist demands merely to stay in power.
Several opinion polls see Sanchez's Socialist party winning elections but likely unable to form a majority in parliament, even with Podemos.
Polls say the PP, Ciudadanos and Vox — which has surged recently thanks to its hard line against Catalan separatism — could be able to form a majority.
A recent survey for eldiario.es, an online newspaper, found right-wing parties and Vox would win 51.2 per cent of votes, while the Socialists and the far left Unidos Podemos could only manage a 39.5 per cent share of the vote.
That would lead to a coalition government with the PP and Ciudadanos, formed with the support of Vox — which is what happened in the southern region of Andalusia after local polls there in December.
“Tensions between the central government and Catalonia are likely to increase in this scenario,” said Steven Trypsteen, ING economist for Spain and Portugal.
The other scenario, he said, could be that the right-wing bloc does not get enough lawmakers to form a majority.
In that case, “political gridlock” would be possible, he said.