The investigation had embarrassed the Saudi royal family, on whom the alleged £60 million bribes were supposed to have been spent, and threatened a new £10 billion defence deal awarded to BAE by the Kingdom.

Lord Goldsmith, the Attorney General, told the House of Lords yesterday that the SFO would have needed a further 18 months to complete its investigation into BAE with no certainty of being able to make a case.

He said that he had spoken to the Prime Minister and the heads of the intelligence services and concluded it was in the national interest to stop the investigation.

He told the Lords: “They [the PM and others] have expressed the clear view that continuation of the investigation would cause serious damage to UK/Saudi security, intelligence and diplomatic co-operation, 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.”

Norman Lamb, the Liberal Democrat MP who has followed the case closely, said: “If ever there was a final nail in the coffin of this government’s reputation this is it. Coming a fortnight after the Typhoon threat from the Saudis this destroys Britain’s reputation for good governance.”

BAE, the UK’s prime defence contractor and Britain’s biggest manufacturer, has been under fire for allegedly setting up a slush fund to bribe Saudi officials and businessmen during the 1980s. BAE has consistently denied any wrongdoing.

The alleged bribes from Britain’s prime defence contractor were part of the £40 billion al-Yamamah contract for BAE to supply the Royal Saudi Airforce with 200 Tornado fighter jets. The Saudi royal family was understood to be furious that the SFO has been allowed to rake through the al-Yamamah deal and embarrass senior members who were involved in the procurement.

The Saudis threatened to cancel a £10 billion agreement signed with the British Government and BAE only three months ago. This deal will lead to BAE supplying the Saudis with 72 Typhoon Eurofighters and the total value of the contract could be worth as much as £20 billion over the 20-year life of the programme.

Tony Blair backed the Ministry of Defence in its demands to shut down the SFO investigation as fears grew that the case would alienate the Saudis. However, critics claim that domestic political considerations and the need to safeguard jobs at BAE are the real reasons for dropping the case. The Saudi Typhoons will keep BAE’s Wharton factory in Lancashire, which employs over 9,000 people, operating at full capacity until 2014.

The SFO refused to comment last night but issued a statement: “It has been necessary to balance the need to maintain the rule of law against the wider public interest.”

It added: “This decision has been taken 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.”

BAE welcomed the decision to end the investigation.

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