Debian prompt takes variables in PS1 literally

I have a small problem with the prompt on a debian server, I keep getting the variables as literals:

    PS1='\u \w $'
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gives me a prompt showing:

    \u \w $

where it should imho show:

    username dirname $

What am I missing here?

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Are you sure your shell is bash ? With other shells (such as dash), such variables may not work.