An East London headteacher who helped raise funds for Tony Blair's city academies was told by prosecutors today that he would not face charges in the cash-for-honours inquiry.

Des Smith was the first person to be arrested in connection with the investigation in April last year. Since then three other senior Labour figures, including Lord Levy, the Prime Minister's personal fundraiser, have been arrested and repeated police visits to Downing Street have overshadowed Mr Blair's last months in office.

News that Mr Smith would not be charged came as Britain's top civil servant told MPs that the Government was functioning as usual and was not being hindered by what he described as "deeply worrying" press coverage of the case.

During a conversation with an undercover reporter from The Sunday Times last year, Mr Smith implied that funders for Labour's academy scheme might be rewarded with political honours. Today the Crown Prosecution Service said that his comments did not warrant prosecution because they did not directly concern funding for political parties.

"Mr Smith’s case concerned funding for City Academies. It did not involve allegations concerning loans or donations to political parties. We do not expect any further evidence to come to light relating to him," read a CPS statement.

"Although it is clear that Mr Smith made some indiscreet comments to an undercover journalist, his conversations did not provide evidence that he was trying to obtain funding for City Academies in exchange for honours."

Mr Smith said he learned of his reprieve from his barrister this morning. "It’s just been going for so long. I’m relieved that it’s over," he said. "It was nonsense from the beginning."

Since late last year the priority of the police inquiry, which is led by Deputy Assistant Commissioner John Yates, has shifted to allegations of a possible cover-up within Downing Street ahead of the original alleged offences of offering political honours in return for secret donations to the Labour party.

Today The Times reported that Jonathan Powell, the Prime Minister's chief of staff, is likely to be questioned under caution for a second time about his role in the affair.

Mr Powell, 50, is Mr Blair's most senior aide. The police want to ask him about a meeting he attended with Lord Levy, the chief fundraiser, Ruth Turner, No 10’s director of government relations, and John McTernan, director of political operations, early last summer after the arrest of Mr Smith.

Detectives have told the Crown Prosecution Service (CPS) that they have received information that the meeting discussed how to "handle" the police inquiry, a source said.

Downing Street declined to comment on the report today as Sir Gus O'Donnell, the Cabinet Secretary and Head of the Home Civil Service, told the Public Administration Committee that Downing Street was "getting on with things" as usual and co-operating fully with the police inquiries.

Asked whether Scotland Yard had been given access to all documents relating to the case, Sir Gus said that detectives had told him they were happy with the level of help they were receiving in the past. "There’s no reason to think that’s changed," he said. "We’ve complied fully with all requests."

He also denied press allegations of a second e-mail system used by senior Downing Street staff, on which details of political honours were discussed and kept hidden from police. "There’s no second e-mail system inside No 10. I find it deeply worrying just how much media coverage there is. That’s all I can say," he said.

Sir Gus said that the Government continued to function despite the heavy press coverage of the inquiry. "I think Government’s getting on with things. In that sense we carry on."

Mr Blair was spared any questions on the cash-for-honours affair during his own appearance before MPs today. At his six-monthly appearance before the House of Commons Liaison Committee, the Prime Minister urged his successor, thought to be Gordon Brown, to maintain a strong relationship with America in the face of "a general strain of public opinion" that wants the opposite.

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