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Westminster was rocked today by the news that Peter Mandelson is to return to Cabinet after ending his 15-year feud with Gordon Brown.

The European Commissioner for Trade, who twice resigned under a cloud from Tony Blair's top table, will be made a peer by the Prime Minister and join the Government as Secretary for Business, sitting in the Lords.

John Hutton, the current Business Secretary, will be promoted to Defence Secretary, taking over from Des Browne, who will leave the Cabinet.

In other moves, Geoff Hoon, the Chief Whip, takes over at Transport from Ruth Kelly, who announced last week that she wants to spend more time with her young family. Mr Hoon will be replaced by the Brownite fixer Nick Brown.

The other Cabinet entrant is Liam Byrne, the Immigration Minister, who will become Mr Brown's new enforcer as Cabinet Office minister.

But it will be the return of "Lord Mandelson" which will grab the headlines after the most astonishing political reconciliation - and resurrection - of modern times.

Mr Mandelson and Mr Brown were were once close friends and, with Mr Blair, created New Labour. But when Mr Mandelson sided with Mr Blair in the 1994 leadership election, their relationship nosedived and it is only in recent months that the two men have resumed regular contact.

His appointment will be seen as a dramatic move by Mr Brown to shore up his own position after speculation that some Blairite ministers were preparing to walk out of his Government. Appointing the ultimate Blairite is perhaps the only way to bind those figures in more closely to his government.

But it is nevertheless a huge gamble. The 54-year-old, who stood down as MP for Hartlepool in 2004 to take the job in Brussels, remains a divisive figure in the party despite his obvious political and electioneering skills.

As Business Secretary, Mr Mandelson will be returning to the department he briefly headed when it was known as the Department for Trade and Industry in 1998 before it emerged that he had bought a house in Notting Hill with an interest-free loan from the millionaire Labour MP Geoffrey Robinson.

There will be a structural change, however. The Department for Business, Enterprise and Regulatory Reform as headed by Mr Hutton will be split and a new department spun off with responsibility for energy and climate change - to be headed by Ed Miliband, the former Cabinet Office minister and Brown ally.

Hilary Benn, currently in charge of Defra, retains responsibility for food and agriculture.

Today's reshuffle is being portrayed as an attempt to strengthen the Government's economic basis and its ability to tackle the financial crisis.

Mr Brown will announce the creation of a new Cabinet economic committee - modelled on the Cobra committee which handles national security - to spearhead the Government's response to the credit crunch and its economic aftermath.

He will also appoint a number of "business ambassadors", including Sir John Bond of Vodafone, John Browne, the former head of BP, and Mervyn Davies of Standard Chartered.

Mr Mandelson's return to frontline UK politics was welcomed by business leaders - even though some had lobbied for Mr Hutton to remain in his post. "Mr Mandelson’s experience will mean that he can do away with the probationary period and get straight into the business of dealing with the current credit crunch," said John Wright, chairman of the Federation of Small Businesses.

But several union leaders were said to be "too shocked" to comment on the return of the man once dubbed "the Prince of Darkness" and the leftwinger John McDonnell said: "The whole Labour movement will be utterly perplexed at what the Prime Minister’s motives are. This is an extraordinary step backwards into the worst elements of the Blair era, to reinstate possibly the most divisive figure in Labour’s recent history."

Mr Mandelson is to leave his Brussels job immediately and will be temporarily replaced as Britain's nominated commissioner by Lady Ashton, leader of the Lords. A permanent replacement will be named at the end of next year.

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