Senior Muslims appointed by Charles Clarke to investigate the causes of the attacks, in which 52 commuters died, also warned that the Home Secretary's anti-terror legislation could prove dangerously counter-productive.
Ministers have always denied there was any link between the wars in Iraq and Afghanistan and the radicalisation of young British Muslims. But they were contradicted in the final report of seven working parties of Muslim leaders set up after the London attacks by the Home Office.
It concluded: "British foreign policy - especially in the Middle East - cannot be left unconsidered as a factor in the motivations of criminal radical extremists. We believe it is a key contributory factor."
The report added: "The Government should learn from the impact of its foreign policies on its electors."
The working groups said "radical impulses" among the Muslim community were often triggered by "perceptions of injustices inherent in western foreign policy".
They said: "Criticism of some British foreign policies should not be assumed to be disloyal. Peaceful disagreement is a sign of a healthy democracy. Dissent should not be conflated with 'terrorism', 'violence' or deemed inimical to British values."
Their conclusions echoed a leaked Home Office/Foreign Office memorandum in July which concluded that the Iraq war was a key cause of young Muslims turning to terrorism.
The Prime Minister's official spokesman acknowledged that the Government had to do more to explain the "fundamental point" of its policy in Iraq and Afghanistan, which is to bring democracy to those nations.
Hazel Blears, the Home Office minister, said: "They are telling the Government some fairly challenging things and not just telling the Government what they think we wanted to hear."
The working parties' report also attacked the controversial plan in the Terrorism Bill, which completed its turbulent Commons passage yesterday, over a new offence of "glorifying" terrorism.
"The proposal ... as currently formulated could lead to a significant chill factor in the Muslim community in expressing legitimate support for self-determination struggles around the world," it said.
Plans to give the police powers to close down mosques which were being used by Islamic extremists could deprive law-abiding communities of their place of worship. And moves to ban radical Islamist organisations, such as Hizb ut-Tahrir and al-Muhajiroun, could send them underground and make them "more problematic in the future".
Mark Oaten, the Liberal Democrat home affairs spokesman, said: "These findings confirm what the Government's own leaked documents have shown - that the war in Iraq has encouraged home-grown terrorism. Proposals such as banning non-violent Muslim organisations and closing down mosques will simply make matters even worse."
The working groups recommended setting up a media unit to counter "Islamophobic" media reporting, setting up a British-Islam website to counter extremist Muslim sites on the internet and a drive to teach English to imams.
Scrap over civil service and looming battle with Lords threaten Blair
Tony Blair faces a fresh battle over planned anti-terror laws as peers warned of continuing unrest over key proposals despite the dramatic defeats inflicted by MPs.
Opposition parties warned that the Government faced yet more pressure over the Terrorism Bill when it comes to the Upper House later this month.
The House of Lords is likely to accept the plan to increase powers to hold suspects without charge for up to 28 days, although peers are likely to call for extra safeguards. But sources said peers were still deeply concerned by plans for a new offence of inciting and glorifying terrorism. Major defeats in the Lords would increase pressure on Mr Blair, and threaten to embarrass the Government when the legislation returns to the Commons in the new year.
The Terrorism Bill completed its passage through the Commons yesterday and will have its second reading in the Lords on 21 November.
Yesterday Conservatives and Liberal Democrats warned they were worried by plans to outlaw indirect incitement to terrorist acts.
They warned that it was essential to force prosecutors to prove intent. And they called for measures to protect academics, libraries and journalists from prosecution if they published material which might subsequently aid extremists.
Work and Pensions
A further blow to Tony Blair's authority has been inflicted by a senior civil servant in a row over his drive for cuts in benefits for the sick and disabled.
Sir Richard Mottram, Permanent Secretary at the Department for Work and Pensions (DWP) has blocked the appointment of a senior member of the No 10 Policy Unit to spearhead the changes.
Gareth Davis was chosen by Mr Blair to become head of policy at the DWP after the resignation of David Blunkett as Secretary of State.
Mr Blair appointed John Hutton to replace Mr Blunkett and promoted Mr Davis with clear orders to overcome resistance in DWP to his radical proposals, which include replacing part of the Incapacity Benefit with vouchers for training.
One minister said: "Mottram said he was in charge of civil servants in his own department and he was not having it. It's now a question of who is running the policy."
In Whitehall, the refusal by Sir Richard to rubber stamp the appointment of Mr Davis is seen as a blow against Mr Blair's autocratic style.
Government sources confirmed last night that Mr Davis would remain at No 10. There are suspicions in Downing Street that DWP chiefs oppose the radical changes being demanded by Mr Blair.
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