David Cameron will move to break the political deadlock over how the rate-fixing scandal should be investigated by forcing the issue to a vote in the House of Commons tomorrow.
The Prime Minister announced plans on Monday to put senior parliamentarians, rather than a judge, in charge of the inquiry into the manipulation of interest rates by bankers.
But Labour is insisting the issues involved are so serious they have to be scrutinised by an independent inquiry free of politicians – and is refusing to promise to take part in a parliamentary inquiry.
Tensions have also been raised by attacks by Mr Cameron and George Osborne, the Chancellor, on the previous Labour administration for allowing the abuse of interest rates to develop on its watch.
The Government's problems were further heightened by the warning by Andrew Tyrie, the Tory MP chosen to head the inquiry, that he would pull out if his investigation was not supported by all parties. He said: "I am certainly not going to want to run an inquiry that is in any sense partisan or perceived to be partisan."
MPs will be asked to choose tomorrow between the alternatives of a parliamentary investigation, as proposed by the Coalition, or the judge-led inquiry advocated by Labour.
The Government looks certain to win a majority for the former and ministers would then urge MPs of all parties to close ranks and co-operate with the committee investigation.
Downing Street insisted the Government was committed to an all-party inquiry and suggested it could have a wider remit than expected.
A senior Labour source said: "This is a Government in retreat; 48 hours ago we did not have an inquiry and 24 hours ago we did not have a vote. Now David Cameron must go one step further and have an independent, judge-led inquiry."
Labour refused to be drawn on whether it would co-operate with the parliamentary inquiry if it loses tomorrow's vote, insisting it could still harness public opinion to defeat the Government on the issue.
Ed Balls, the shadow Chancellor, insisted he had not given up hope of persuading ministers to accept a judicial inquiry. He said: "We need as politicians to say: 'look we all got this wrong, there needs to be big change'.
"And we can only do that in the open scrutiny of proper hearings with proper disclosure from the politicians and the bankers."
Mr Osborne said the judge-led inquiry favoured by Labour would take two years to set up and run and would not result in legislation until 2016-17.
"It is not what the country wants. A proper parliamentary inquiry with real powers to hold evidence under oath [will] get some answers in the next few months instead of waiting until a decade after the scandal itself. So let's get on with the job," he told BBC Radio 4.
Simon Hughes, the Liberal Democrat deputy leader, said: "A judge-led inquiry into banking should now not be the priority. The failures of the banking system and specifically the attempt to fix interest rates comes after a successful investigation by the regulator.
"For years people like my friend Vince Cable warned about the consequences of the gambling by spivs in the City."
A poll by TNS BMRB, a research agency, found 82 per cent of the public supported tighter regulation of the financial industry even if it resulted in some banks leaving Britain. Less than one-fifth believed the Government should be more careful in its comments because of the contribution banks make to the public finances.Reuse content