The allegations of bribery and corruption in BAE’s £43 billion oil-for-arms deal with Saudi Arabia is causing some red faces among British officials in Washington – but not from embarrassment. Instead, it is a symptom of how they are collectively holding their breath over whether the Americans are going to start paying serious attention to these charges.

At stake is BAE’s strategy for rapid US expansion where it is already by far the Pentagon’s biggest foreign defence contractor and has rattled America’s established military-industrial complex along the way.

Since 1999 BAE has made 15 acquisitions in the US and a proposed $4.5 billion (£2.3 billion) takeover of Armor Holdings will make it the sixth-largest supplier to the Department of Defence. It hopes to win big contracts for the Mine-Resistant Ambush Protected Vehicle, as well as benefit from the Future Combat System Project.

The Ministry of Defence (MoD) fears any scandal could lead to the unravelling of the closely intertwined British and US military. If BAE suddenly finds itself operating in a more hostile marketplace, it would be forced to look more towards Europe for collaborative deals.

This in turn would threaten the principle underpinning the UK’s defence strategy of ensuring compatibility in military hardware – even raising doubts that future wars will be fought alongside the US.

Gordon England, US deputy Defence Secretary, is believed to have expressed “surprise” about the bribery allegations.

So too have officials at the US State Department who were working on a new defence cooperation treaty with Britain, agreed in outline by President Bush and Tony Blair last month. “There was puzzlement about exactly what the President meant,” said one source close to the negotiations, “and this may be a good reason to forget about it for now.”

It is understood that questions are being asked of British diplomats about whether “we should be doing business with BAE”. US officials are concerned about claims of £120 million payments made each year to the Saudi Embassy in the US through a bank account in Washington. This money was allegedly channelled to Prince Bandar bin Sultan, the former Saudi Ambassador.

US investigators are already said to have examined some of the Washington accounts. But they have found it difficult to determine if payments were illegal, not least because Saudi government funds are mixed with those of the Kingdom’s royal family, of which Prince Bandar is a prominent member. Both Prince Bandar and BAE strongly deny any wrongdoing.

The MoD is telling Americans privately that the money was profit accrued from a rise in oil prices under the deal which the Saudis then asked BAE to use for “paying other bills”. These included building roads in the Kingdom and running their Embassy in Washington.

Even some MoD sources in London acknowledge that this was a highly unusual arrangement and eyebrows have been raised by the sums being spent on Prince Bandar’s diplomatic mission – which dwarf the cost of running Britain’s own Embassy in Washington.

It remains possible that the Department of Justice could begin a formal inquiry into whether BAE has broken the US’s Foreign Corrupt Practice Act.

More likely is that the Committee on Foreign Investment in the United States (CFIUS), an interagency panel based in the US Treasury, will order a formal 45-day inquiry into BAE’s proposed acquisition of Armor Holdings.

Some of BAE’s US rivals, including Lockheed Martin and General Dynamics, had also been interested in the takeover and the faintest pressure from the “Buy American First” lobby in Congress could trigger such an investigation.

But so far, at least, BAE has avoided any such scrutiny. The days are now being counted down to August when Congress will go into summer recess and the issue may well be forgotten.

A BAE spokeswoman said yesterday: “We have got people in the Pentagon walking the corridors and talking to the politicians and we don’t think there will be a problem with the acquisition of Armor Holdings.

“We are a trusted company and are known to be exemplary stewards of American businesses. We are seen as an example of how a foreign company can be successful in the US.”

One reason for BAE’s insulation against such storms is the close relationship between Prince Bandar and the Bush family which means there is little inclination on the part of the Administration to dig deeper into the issue.

At the same time, Democrats in Congress this summer are preoccupied by Iraq and the issue of when – or how – America can start bringing troops home. A Capitol Hill source said yesterday: “Of course people are aware of the BAE thing – there seems to be lot of smoke and maybe some fire – but right now there are not enough firefighters.”

There is also some scepticism about whether the US should get involved in a story being driven by the British media, which is commonly perceived in Washington as prone to exaggeration and distortion.

“A lot of people think that if our ally, Tony Blair, said there is no need for an inquiry, that’s good enough for them,” said a Congressional staff member.

Loren Thompson, a defence analyst at the Lexington Institute, said: “The North American branch of BAE is pretty much regarded here as being run by honorary US citizens. It has kept out of this Saudi business which appears to have been done back in Britain.

“And in America it takes a mushroom cloud for us to take notice of something going on elsewhere in the world.”

Sir Nigel Sheinwald, the Prime Minister’s foreign policy adviser and soon to be US Ambassador, is expected to discuss the issue with Stephen Hadley, President Bush’s national security adviser, in talks next week.

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