The Guardian newspaper reported that it had obtained documents suggesting that the company spent millions of pounds on travel, luxury accommodation and other expenses for Saudi officials visiting London.

Saudi Arabia is a major purchaser of defence systems, ranking as one of BAE's biggest customers.

BAE chief executive Mike Turner on Thursday morning said the allegations were unfounded.

"We deny all such allegations. We operate in line with the laws of the United Kingdom and all other countries in which we operate," he said.

Upturn

The denial came as the Farnborough-based company turned in higher first-half profits, helped by a strong performance from commercial aircraft maker Airbus.

The company said profits before taxes and after financial charges for the first six months of 2003 came in at �56m ($90m), up from �41m during the same period last year.

Excluding financial charges, BAE's pre-tax profits were down 7% on the year at �333m, but still at the top end of analysts' forecasts.

Sales dipped to �5.68bn from �5.7bn one year earlier.

Mr Turner said the improved result reflected a "solid operational performance" across the group's businesses, especially from Airbus, in which BAE owns a 20% stake.

"Despite the continuing difficult commercial aerospace environment, the Airbus management team delivered a strong performance in the first half," he said in a statement.

Airbus, Europe's flagship aircraft maker, has notched up strong sales in 2003 despite the continued downturn in the air travel market.

Mr Turner also drew attention to BAE's "large" order book, which has been swelled in recent months by an order for 86 new Hawk jets from the UK's Royal Air Force.

Shares bounce

BAE said the "good progress" underpinning its defence businesses in the first half of the year was set to continue in the second half.

City investors were unfazed by the slush fund allegations, marking BAE shares higher early trade, although the stock finished the day 4p lower at 470p.

The early rise reflected investor relief that a series of problems which hit the company last year, including hefty asset write-downs and costly overruns on key Ministry of Defence (MoD) contracts, now seem to be resolved.

However, analysts have raised fears that the MoD may be forced to scale back some BAE contracts as it comes under increasing pressure from the Treasury to help meet the escalating cost of Britain's military engagement in Iraq.