In recent weeks, BAE and the Saudi embassy had frantically lobbied the government for the long-running investigation to be discontinued, with the company insisting it was poised to lose another lucrative Saudi contract if it was allowed to go on. This came at a time when the SFO appeared to have made a significant breakthrough, with investigators on the brink of accessing key Swiss bank accounts.

However, Lord Goldsmith consulted the prime minister, the defence secretary, foreign secretary, and the intelligence services, and they decided that "the wider public interest" "outweighed the need to maintain the rule of law". Mr Blair said it would be bad for Britain's security if the SFO was allowed to go ahead, according to the statement made in the Lords by Lord Goldsmith. The statement did not elaborate on the nature of the threat.

BAE claimed that it was about to lose out on a third phase of the Al-Yamamah deal, in which the Saudis would buy 72 Typhoon aircraft in a deal worth £6bn. The Saudis had also hinted that they would do a deal with the French instead if the inquiry pushed ahead. A 10-day ultimatum was reportedly issued by the Saudis earlier this month.

A PR campaign headed by Lord Bell saw MPs from all parties urging the dropping of the investigation, citing fears that jobs would be lost in their constituencies. But in its statements last night the government said commercial considerations had played no part in the decision.

The decision was condemned last night as naked political interference in a criminal case. Norman Lamb, the Liberal Democrat chief of staff, said the government had succumbed to Saudi pressure. "I think it's because the inquiry has been making substantial progress that it's been brought to an end," he said.

The SFO's director, Robert Wardle, issued a terse statement saying he had dropped the Saudi end of the investigation "following representations that have been made both to the attorney general and the director of the SFO concerning the need to safeguard national and international security".

Shares had begun to rise in BAE and major suppliers such as Rolls-Royce in the last two days, as rumours reached the City that a deal had been done to appease the Saudis. Lord Goldsmith's statement was unusual in that it did not refer to the claimed threats to British jobs, but instead concentrated on "national security".

The destruction of its inquiry will be a severe blow to the SFO which has spent more than £2m on what was its most extensive current investigation, and taken hundreds of pages of statements from witnesses. One witness who gave evidence to the SFO, Peter Gardiner, a director of a travel agent used to make alleged slush fund payments, said last night: "It's an interesting signal that this gives to industry and the world I am thinking of the hundreds of hours I have wasted and all the personal problems this has caused me."

BAE, in a statement, said it welcomed the dropping of the inquiry. But the company and its executives may not yet be out of the woods. The attorney general has allowed investigations to continue into BAE activities in Romania, Chile, the Czech Republic, South Africa and Tanzania, which legal sources say are making strong progress.

The UK made overseas bribery illegal in 2002, under US pressure. Labour ministers subsequently claimed they were determined to stamp out corruption, but in practice no prosecutions have taken place under the new law.

Clare Short, Mr Blair's former cabinet colleague, said: "This government is even more soiled than we thought it was. It means that BAE is above the law."

She added: "The message it sends to corrupt businessmen is carry on - the government will support you."

Liberal Democrat Lord Goodhart said: "If, as appears to be the case, this further investigation is being stopped because of potential damage to security, intelligence and diplomatic relations with Saudi Arabia, doesn't that amount to blackmail by Saudi Arabia, to prevent this matter going forward?"

Attorney general's statement

"It has been necessary to balance the need to maintain the rule of law against the wider public interest. No weight has been given to commercial interests or to the national economic interest.

The prime minister and the foreign and defence secretaries have expressed the clear view that continuation of the investigation would cause serious damage to UK/Saudi security, intelligence and diplomatic cooperation, which is likely to have seriously negative consequences for the UK public interest in terms of both national security and our highest priority foreign policy objectives in the Middle East."

They stressed they had not chosen the timing of the interview with Mr Blair, leaving No 10 open to the charge that its officials had hoped to dampen the explosive impact of Mr Blair's interview in the cacophany of other events.

The government selected yesterday to close 2,500 post offices, drop a Serious Fraud Office inquiry into allegations that BAE had paid bribes to senior figures in the Saudi royal family in return for contracts, and publish a white paper on the future of British airports. Lord Stevens had also made clear weeks ago that he intended to publish his report into the death of Princess Diana yesterday.

Chris Grayling, a member of the shadow cabinet, said: "Five years after Labour launched the concept of burying bad news, Mr Blair's spin doctors are back to their old tricks." A Labour insider said it appeared to be "take out the trash day".

Police questioned Mr Blair about the circumstances in which he nominated four party lenders for peerages, and whether there had been any conspiracy to keep from the Lords Appointments Commission that all four had lent the party considerable sums ahead of the 2005 election.

Mr Blair was told before yesterday's interview that he would not be questioned under caution so he chose only to have a civil service notetaker present, rather than a lawyer.

The prime minister kept the timing of the interview from some of his most senior officials as well as cabinet colleagues.

Mr Blair's spokesman would not say how many officers were involved in the interview, although it is understood that Acting Deputy Assistant Commissioner John Yates, who is heading the inquiry, was not among them.

Witness interviews are not usually tape recorded and those being questioned are free to leave at any time. Mr Blair's official spokesman was only informed after the interview had been completed and within 20 minutes hastily convened a briefing of political journalists in the Commons.

During the course of yesterday's questioning, Mr Blair was said to have defended his actions in awarding the peerages in terms he has used in public before. The four nominations under question are those offered to Barry Townsley, Chai Patel, Sir David Garrard and Sir Gulam Noon. Collectively they lent Labour £4.25m ahead of the 2005 election.

Mr Blair's spokesman said: "The prime minister explained why he nominated each of the individuals and he did so as party leader in respect of the peerages reserved for party supporters as other party leaders do. The honours were not, therefore, for public service but expressly party peerages given for party service. In these circumstances, the fact that they had supported the party financially could not conceivably be a barrier to their nomination."

Mr Blair apparently robustly pointed out that party donors are in themselves carrying out a public service.

But the Lords Appointments Commission blocked the nominations only after learning the quartet had lent money to the party. It is alleged that Lord Levy advised the four to give loans, and even suggested they change their nomination forms to remove any reference to a financial connection. Commercial loans do not have to be disclosed in public, either to the government regulator, the Electoral Commission, or to the Lords Appointments Commission.

If the police are to place charges against Lord Levy, they would have to have secured witness statements from some of the nominees saying that Lord Levy suggested their cash would lead to a peerage. Lord Levy was contacted by Labour shortly before the last election to undertake a last-minute fundraising spree, as it became clear the Conservatives were going to greatly outspend Labour.

Although it is conceivable the police will re-interview Mr Blair, and this time under caution, the guidance suggested this is not the case.

The prime minister's spokesman said: "I have no reason to believe that there will be any other interviews. That's a matter for the police. I don't talk to the police." Asked whether Mr Blair had got the impression he faced another interview, he replied: "I say that with good reason."

However, Angus MacNeil, the Scottish National party MP whose complaint triggered the investigation, said that Mr Blair could face further questioning.

"This revelation will be shaking the very foundations of Westminster," he said. "We know that a number of Downing Street officials have been questioned many times by the police and this could be only the first of such a series of questions for the prime minister, also."

The Metropolitan police wants to put a file to the Crown Prosecution Service's lawyer in the new year. Detectives have already sent material including potentially incriminating emails and other documents from those involved in the money-raising process for Labour to the CPS for their advice. Prosecutors have been giving their assessments of the strength of evidence and on investigative avenues detectives may want to follow.

In recent weeks, BAE and the Saudi embassy had frantically lobbied the government for the long-running investigation to be discontinued, with the company insisting it was poised to lose another lucrative Saudi contract if it was allowed to go on. This came at a time when the SFO appeared to have made a significant breakthrough, with investigators on the brink of accessing key Swiss bank accounts.

However, Lord Goldsmith consulted the prime minister, the defence secretary, foreign secretary, and the intelligence services, and they decided that "the wider public interest" "outweighed the need to maintain the rule of law". Mr Blair said it would be bad for Britain's security if the SFO was allowed to go ahead, according to the statement made in the Lords by Lord Goldsmith. The statement did not elaborate on the nature of the threat.

BAE claimed that it was about to lose out on a third phase of the Al-Yamamah deal, in which the Saudis would buy 72 Typhoon aircraft in a deal worth £6bn. The Saudis had also hinted that they would do a deal with the French instead if the inquiry pushed ahead. A 10-day ultimatum was reportedly issued by the Saudis earlier this month.

A PR campaign headed by Lord Bell saw MPs from all parties urging the dropping of the investigation, citing fears that jobs would be lost in their constituencies. But in its statements last night the government said commercial considerations had played no part in the decision.

The decision was condemned last night as naked political interference in a criminal case. Norman Lamb, the Liberal Democrat chief of staff, said the government had succumbed to Saudi pressure. "I think it's because the inquiry has been making substantial progress that it's been brought to an end," he said.

The SFO's director, Robert Wardle, issued a terse statement saying he had dropped the Saudi end of the investigation "following representations that have been made both to the attorney general and the director of the SFO concerning the need to safeguard national and international security".

Shares had begun to rise in BAE and major suppliers such as Rolls-Royce in the last two days, as rumours reached the City that a deal had been done to appease the Saudis. Lord Goldsmith's statement was unusual in that it did not refer to the claimed threats to British jobs, but instead concentrated on "national security".

The destruction of its inquiry will be a severe blow to the SFO which has spent more than £2m on what was its most extensive current investigation, and taken hundreds of pages of statements from witnesses. One witness who gave evidence to the SFO, Peter Gardiner, a director of a travel agent used to make alleged slush fund payments, said last night: "It's an interesting signal that this gives to industry and the world I am thinking of the hundreds of hours I have wasted and all the personal problems this has caused me."

BAE, in a statement, said it welcomed the dropping of the inquiry. But the company and its executives may not yet be out of the woods. The attorney general has allowed investigations to continue into BAE activities in Romania, Chile, the Czech Republic, South Africa and Tanzania, which legal sources say are making strong progress.

The UK made overseas bribery illegal in 2002, under US pressure. Labour ministers subsequently claimed they were determined to stamp out corruption, but in practice no prosecutions have taken place under the new law.

Clare Short, Mr Blair's former cabinet colleague, said: "This government is even more soiled than we thought it was. It means that BAE is above the law."

She added: "The message it sends to corrupt businessmen is carry on - the government will support you."

Liberal Democrat Lord Goodhart said: "If, as appears to be the case, this further investigation is being stopped because of potential damage to security, intelligence and diplomatic relations with Saudi Arabia, doesn't that amount to blackmail by Saudi Arabia, to prevent this matter going forward?"

Attorney general's statement

"It has been necessary to balance the need to maintain the rule of law against the wider public interest. No weight has been given to commercial interests or to the national economic interest.

The prime minister and the foreign and defence secretaries have expressed the clear view that continuation of the investigation would cause serious damage to UK/Saudi security, intelligence and diplomatic cooperation, which is likely to have seriously negative consequences for the UK public interest in terms of both national security and our highest priority foreign policy objectives in the Middle East."

Lord Levy is one of the most important fundraisers for the Labour Party and Tony Blair's unofficial envoy to the Middle East. He met Blair at a dinner party in 1994 held by Gideon Meir, a senior Israeli diplomat, and became his tennis partner. Levy was in charge of donations to the 'private trust' which funded Tony Blair's office before the 1997 election (which reached £7 million), and is now the chief fundraiser for the 'high value' donors account at the Labour Party, along with his deputy Amanda Delew (who worked with him at Jewish Care). He is reported to have raised £12 million for the 'high value' fund before the 1997 election, becoming known as 'Mr Cashpoint'. Straight after the election he was given a peerage. He used to work with Dr Henry Drucker, whose company Oxford Philanthropic was brought in by the Labour Party to advise on gaining large corporate donations, but they fell out over Drucker's description of Labour's 'blind trust' funds as 'evil' (the trusts have since all been closed down). At one meeting with Levy in his Totteridge mansion, Levy apologised to Drucker for not offering him a cup of coffee, but explained 'You'll have to do without as none of the servants are about and I don't know how to work the machine myself.'

He set up Magnet Records in 1972 with help from Maurice Oberstein, Head of CBS Records, and made millions from artists like Alvin Stardust, Chris Rea, Dollar, Darts and Bad Manners, at one point was selling 8% of all records in the UK. Some former employees of Magnet have complained that he was a tyrant who shouted at staff and threw ashtrays around. He sold Magnet to Warner Brothers in 1988 for £10 million and later set up another record company called M&G (named after himself and his wife Gilda), where he paid himself a salary of £308,657. He sold M&G in 1997.

Although a multi-millionaire, he only paid £5,000 in tax in 1998-9 and less than £10,000 in 1997-8 as he said he wasn't working. He runs a private company called Wireart, an investment company which was based in an oversea tax haven until 1997. Wireart paid him £160,000 (plus £50,000 expenses) for work as a management consultant in 1998-9 at the time he wasn't working. Since 1992 he has been Chairman of Jewish Care, one of the UK's biggest charities (he was asked to join by the Tory minister Lord Young), raising as much as £60 million.

hase House, Levy's home in Totteridge (north London), has 5 large bedrooms, 3 sitting rooms, tennis court, swimming pool, a games room, palm trees, a large garage for his chauffeur-driven Jaguar and Bentley and a seperate annexe for his servants. He spent £1.3 million refurbishing the house after he bought it in 1997 for £1.3 (his previous house was sold for £3.4 million). The rooms are lined with marble, granite and limestone.

He also owns a villa in Herzliya Pituah, an exclusive suburb of Tel Aviv in Israel, which he bought after selling another villa nearby for £4 million. He has acted as a fundraiser for Ehud Barak, the Israeli Prime Minister, and maintains a close relationship with him. His son Daniel worked for the Israeli Justice Minister Yossi Beilin, to whom Levy contributed campaign funds. Both his children live in Israel.

His role as unofficial envoy for the Middle East took him to 8 different countries in 1999, staying in British Embassies, including Syria, Jordan, Oman, Qatar, Israel, Egypt and Lebanon (where he was accused by the Lebanese Government of bringing them the Israeli position and the British Ambassador had to issue a statement to try and calm the situation down). He was also provided with cars, drivers and staff support. The Embassy in Amman, Jordan, arranged a lunch for him to meet Jordanian politicians.