By Paul Majendie

LONDON, July 13 (Reuters) The police chief heading a probe into political party funding is to brief British lawmakers today amid growing speculation Prime Minister Tony Blair may soon be quizzed by detectives.

Police are investigating allegations that state honours were awarded in return for cash in an escalating row that has damaged Blair's standing and increased calls for his resignation.

Deputy Assistant Commissioner John Yates will brief members of parliament on a committee which scrutinises the government, on the progress of his investigation.

The probe took one step closer to Blair yesterday when Lord Levy, the chief fundraiser for his ruling Labour Party and one of the prime minister's closest allies, was arrested.

Michael Levy, 62, denied any wrongdoing and accused the police of using their arrest powers ''totally unnecessarily''. He was released on bail without charge pending further enquiries.

''The waters are lapping around the prime minister's ankles,'' Scottish nationalist leader Alex Salmond said after the arrest.

Blair faced a barrage of damaging headlines today about the row reaching the door of his Downing Street residence.

''Blair faces police quiz,'' said the Sun tabloid. ''Police quiz Blair next,'' declared the Daily Mail.

The Labour party came under pressure after it said it had received nearly 14 million pounds ( million) of loans from 12 businessmen, some of whom were nominated for seats in Britain's unelected upper house of parliament.

Britain has a complicated system of awards and decorations.

A law was introduced in 1925 making it illegal to sell seats in the upper chamber, the House of Lords, after government abuses.

Police have been investigating all parties in Britain after the row broke out in March. Labour denies the allegations.

A report from the committee which scrutinises the government said today Britain should reform the state honours system to prevent abuse. The deputies called for greater transparency to deter politicians from using it to reward their favourites.

The meeting with Yates will be behind closed doors. A police spokeswoman was unable to give a time for the meeting or give any further details.

The Labour Party, eager to rehabilitate the image of donations, took full-page adverts in newspapers today containing a list of celebrities, businessmen and backers who declared: ''We're proud to help fund the Labour Party''.

REUTERS MQA HT1315