The inquiry will be given powers last used in Lord Scarman's 1981 inquiry into the Brixton riots. It will examine the events surrounding the stabbing of the 18-year-old student while he was waiting for a bus in Eltham, south- east London, in 1993.
In a surprise move, Jack Straw, the Home Secretary, said the inquiry will also identify lessons to be learned for the investigation and prosecution of racially motivated crime. Such an inquiry, which will question the role of the police, Crown Prosecution Service, and the courts, was not expected.
Mr Lawrence's father, Neville, welcomed the announcement as a "step in the right direction".
Headed by the former High Court judge Sir William MacPherson of Cluny, the inquiry has the power to summon any person or to obtain any documents. Refusal to testify would be deemed contempt of court.
The inquiry is expected to last three to six months and should begin in October, when an investigation by Kent police, supervised by the Police Complaints Authority, into the handling of the case by the Metropolitan police, is completed.
The inquiry is expected to examine the role of the police after the CPS discontinued a prosecution for lack of evidence, and a private prosecution collapsed because of insufficient evidence and the inadmissibility of the evidence of a key witness.
Last February, an inquest jury returned a verdict that Stephen had been unlawfully killed in an unprovoked racist attack by five white youths. After the inquest ruling, the Daily Mail named the five young men as Stephen's killers, challenging them to sue for libel if the paper was wrong.
In March, the Lawrence family made an official complaint over the way police investigated the murder, claiming they did not take it seriously. Neville Lawrence said yesterday: "We are happy with what we have got today, but we have waited four years for this."
Imran Khan, the Lawrence family solicitor, said: "Had the police in this case investigated as they should have done, we would not have needed to be sitting here and we would not have had to have knocked on the Home Secretary's door in order to have a public inquiry."
Sir Paul Condon, the Commissioner of the Metropolitan Police, offered his full support to the inquiry.
Other members of the inquiry team are: Thomas Cook, formerly deputy chief constable of West Yorkshire; the Rt Rev John Sentamu, Bishop of Stepney; and Dr Richard Stone, chairman of the Jewish Council for Racial Equality.
Mr Straw said: "I believe this inquiry ... will allow the concerns of the Lawrence family and others to be fully addressed and will identify the lessons to be learned from this tragic case which will be relevant to the future handling of racially motivated crimes."Reuse content