The House of Lords has defeated government plans that churches claimed would restrict their "freedom" to deny jobs to women, homosexuals and transsexuals.
The House of Lords, including 26 bishops, rejected a provision contained in Harriet Harman's Equality Bill three times during a debate on Monday night.
Backed by right-wing Christians, Tory backbencher Baroness O'Cathain moved a motion claiming that ministers wanted to change the status quo which allows religious organisations to discriminate against job applicants on grounds of gender, marital status and sexual orientation.
"My package of amendments is supported by the Church of England, the Catholic Church and others," she declared.
Feeble ministers sought to appease the peers, insisiting that their aim was only to clarify the Bill and pledging that religious organisations' "special status" would be preserved.
They were forced to deny claims in a leaked document that the government had promised the European Commission to tighten the law because it is in breach of EU regulations and could trigger legal action.
GMB union equality officer Jamaljeet Jandu condemned the Lords' decision and warned the government that preserving the status quo would send out the wrong message.
"It is a recipe for employers to pick and choose workers based on likes and dislikes, rather than skills," he said.
Mr Jandu argued that the Lords' anti-equality stance highlighted the urgent need for reform of the second chamber.
"This is a matter of democracy," he stresssed.
Sarah Hill, a former employee of a large evangelical organisation, warned on Monday that too many religious institutes were using the current law to "sack or discriminate against gay and lesbian or divorced employees and the government appears to be doing nothing to help."