Gordon Brown has been thrown on to the defensive over his economic strategy as his political opponents exploit a blistering German attack on his borrowing spree.
A furious Prime Minister hit back at Peer Steinbrück, Germany's Finance Minister, who accused him of making a spectacular U-turn since his years as a prudent chancellor by adopting a "crass" and "breathtaking" policy of "tossing around billions".
Mr Brown replied that refusing to take action to stimulate the world's economies would mean "failing in the role of government". He said: "The important thing is that almost every country around the world is doing what we have been doing."
But he suffered another embarrassing setback when the pound slumped to its lowest rate since launch in 1999 of 1.1238 euros against the single currency. The decline came after figures from the Confederation of British Industry confirmed a sharp downward trend in manufacturing. The Tories said the weak currency was a sign of a weak economy and a weak government.
Mr Brown blamed the unprecedented attack on squabbles within Germany's ruling left-right coalition. Mr Steinbrück is a Social Democrat, and his opposition to measures to stimulate Europe's economies has put him at odds with Angela Merkel, the centre-right Chancellor.
The Prime Minister said: "Actually, the German government is investing more. They have just announced a fiscal expansion so that they can invest in public works and helping their banks and doing these sort of things. I do not want to get involved in what is clearly internal German politics here, because they have a coalition in Germany with different political parties."
Labour sources dismissed Mr Steinbrück's remarkable attack as a "rant". But Steffen Kampeter, the budget spokesman for Ms Merkel's Christian Democrats, said: "Peer Steinbrück's comments have nothing whatsoever to do with internal German politics as Prime Minister Brown has suggested. In questioning the British Government's approach, Peer Steinbrück is exactly expressing the views of the German Grand Coalition.
"After years of lecturing us on how we need to share in the gains of uncontrolled financial markets, the Labour politicians can't now expect us to share in its losses. The tremendous amount of debt being offered by Britain shows a complete failure of Labour policy."
The comments are a gift to the Opposition, undermining Mr Brown's charge that David Cameron is isolated at home and abroad because he is against the £20bn fiscal stimulus announced by the Government last month. The Conservative leader said: "What the German Finance Minister is saying is what we are saying – that this enormous binge of borrowing that the Prime Minister has gone on is going to make the recession worse and the recovery more difficult, and we will all be paying higher taxes in the future as a result. That is why we have got to stop it."
George Osborne, the shadow Chancellor, said the criticism undermined the Government's claims that other countries were following the UK's lead and "vindicated" Tory warnings over the effectiveness of the VAT cut. Writing in today's Independent, he says: "His main attack against the Conservatives was that no one shared our concern about his Government's fiscal insanity. Now that attack has collapsed and we discover the emperor has no clothes."
The Liberal Democrats said Germany's leaders were "fed up being lectured" by Mr Brown on how to run their economy. Vince Cable, the party's Treasury spokesman, backed Mr Steinbrück's criticism of Britain's VAT cut, saying it was not a "sensible way to inject activity into the economy". He said the Germans were "making a case for greater financial discipline".
Mr Brown moved to stop the withering attack overshadowing a two-day meeting of EU leaders in Brussels which began yesterday. He did not complain about it when he held an informal one-to-one meeting with Ms Merkel on the margins of the meeting. Last night she joined Mr Brown as European leaders agreed a £175bn fiscal stimulus to keep European economies moving.
Diplomats said Ms Merkel wants to cut taxes in the run-up to Germany's election next year but is being opposed by her Finance Minister, who has raised VAT in contrast to Britain. The Chancellor is expected to push for a bigger fiscal stimulus in her country after Barack Obama unveils his plan to boost the United States economy on taking office as president on 20 January.
"This is not an issue between Britain and Germany. We don't have any issue with the position of Angela Merkel," one British source said. "We see this as an issue within Germany. It is a bit unfortunate we are being caught in the crossfire."
There were more signs of division in the German government last night. Michael Glos, the Economy Minister, said his country was obliged to bring in measures to stimulate its economy.
Mr Steinbrück's own Finance Ministry tried to cool the row. It issued a statement saying: "There is no question of criticising our British friends. Nothing is further from our minds. The Finance Minister simply made clear, in the context of a debate in Germany, why a temporary cut in VAT is not an appropriate instrument for Germany in the battle against the global recession."