One of the Prime Minister’s closest allies has been arrested on suspicion of conspiracy to pervert the course of justice.

Lord Levy, who is Mr Blair’s special envoy to the Middle East, was first arrested last July and released on bail in connection with an investigation by the Metropolitan Police into the alleged selling of peerages.

A spokesman for Lord Levy said in a statement this afternoon:

“He completely denies any allegation of wrongdoing whatsoever.

“He left the police station in the early afternoon and since there is a continuing investigation he will not make any further comments at this time.”

Suspicion of perverting the course of justice is the reason police gave for arresting another close aide to the Prime Minister, Ruth Turner, earlier this month.

The “cash for honours” scandal started when it emerged that wealthy donors to the Labour party had been encouraged to loan rather than donate money to the party.

Several donors were nominated for peerages and then rejected by the House of Lords Appointments Commission.

Donations have to be publicly declared, whereas loans at a commercial rate do not, leading to accusations that Lord Levy, who is the major fundraiser for the Labour party, had instructed donors not to declare the loans to the commission.

Levy, who is a board member of the British Board of Jewish Deputies, is regarded as one of the best fundraisers in the country.

He has raised tens of millions of pounds for Jewish charities, and used his skills to raise similar amounts for Labour.

He was created Lord Levy of Mill Hill in 1997, but has only spoken once in the Lords.

He has voted in almost 16% of divisions in the Lords but never on gay rights legislation.

SNP MP Angus Macneil complained to the police about the loans, triggering an investigation under the little-used Honours (Prevention of Abuses) Act 1925.

The arrest of Lord Levy, a close friend of the Prime Minister, is another blow for Mr Blair.

Yesterday the Prime Minister announced that the government will not be granting an exemption for Catholic adoption agencies from the Sexual Orientation Regulations.

He had been in favour of an opt-out for the Catholic agencies, but divisions in his Cabinet and protests from his own MPs led him to concede that there would be no exemptions to the regulations, which outlaw discrimination on the grounds of sexual orientation when accessing goods and services.

On 14th December 2006 Mr Blair was interviewed at 10 Downing St by police as part of the investigation.

The Metropolitan Police said last year that they would hand over files this month to the Crown Prosecution Service, who will make a judgement on whether there is enough evidence to prosecute.

Senior members of the Conservative and Liberal Democrat parties have also been questioned as part of the investigation, though none have been arrested.