FOCUS: See you in Europe, Tony

Stephen Byers did not take ministerial red boxes to his constituency as usual last weekend. The Secretary of State for Trade and Industry drove up to Newcastle for Easter with two whole packing cases full of papers about BSkyB's bid to take over Manchester United. As soon as the news broke six months ago that Rupert Murdoch was trying to buy one of the most popular football clubs in the world, the Government knew that it was facing one of the most contentious issues it had had to deal with since coming to power.

The pounds 623m bid exemplified the tension in New Labour between a commitment to community and a dedication to capitalism. It pitted the "people's game" of football against the commercialism of the multi-millionaire media mogul. Tony Blair realised it would be impossible for him to remain loyal to both. And he knew the Government's reaction to the potential deal would be seen as a test of whether it was really committed to ordinary punters or a powerful elite. It would be used to assess how far the Prime Minister would go to protect his relationship with big business.

What made this decision more difficult still was that the businessman in question was not just very big, he was also a bete noir of the left. The BSkyB bid turned the spotlight yet again on the nature of the Faustian pact that Old Labour feared Blair had signed with Murdoch in return for the Sun's support in the run-up to the last general election. If the Government had allowed the deal to go ahead it would have been accused of allowing the media mogul to pull strings; but now the bid has been blocked the question is whether the threads will be severed in revenge. When Byer's predecessor, Peter Mandelson, referred the bid to the Monopolies and Mergers Commission (MMC), Murdoch said he viewed it as a "political" decision. "It is very hard for small shareholders of Sky that we should be punished for the fact that we supported the Government at the last election," he said.

Last week's decision will only have confirmed his frustration, and the papers owned by his empire appear to be gearing up for war already. The Sun did not just condemn the BSkyB decision as a "disgrace" yesterday but also sent out a warning to the Government by putting its report on the same page as a story "proving" that the European single currency is a "disaster".

The love affair between Blair and Murdoch has become an obsession for the left. The trip to Hayman Island, Australia, the lunches in Wapping's executive dining-room, the adjacent seats at Sir David English's funeral - all these have entered the public consciousness as evidence of a blossoming romance. They have become a symbol of New Labour's purported willingness to "sell its soul" for the sake of winning influence.

The links between Downing Street and the media mogul's empire remain strong. Peter Mandelson may not be Trade Secretary any more but he still regularly dines with both Blair and Elisabeth Murdoch, Rupert's daughter and managing director of Sky Networks. Four months before the Manchester United bid, Tim Allan, one of the Prime Minister's proteges, moved from the press office at No 10 to become director of corporate communications at BSkyB. He still plays in the Downing Street football team, Demon Eyes, and goes on golfing expeditions with policy-makers. Conveniently, he was at a dinner party in Soho House with James Purnell, his former flatmate who is in charge of broadcasting in the No 10 policy unit, when the first edition of the Telegraph, with its leak of the MMC recommendations, came out four weeks ago.

But, in fact, the honeymoon between Blair and Murdoch did not last long after the general election. Last year the Sun branded Mr Blair "the most dangerous man in Britain" because of his determination to join the European single currency, and asked whether there was a "gay mafia" at work in government. Last month, Blair and Murdoch let it be known that they had "agreed to differ" over economic and monetary union after a conversation at Downing Street earlier this year. A contract given to Peter Mandelson's special adviser Benjamin Wegg-Prosser by the Sun editor, David Yelland, was terminated before he even began the job because of fears that he would try to change the paper's line on Europe.

Downing Street has also begun to hit back - Alastair Campbell, the Prime Minister's press secretary, regularly insults the "mad Eurosceptic British press", including the Murdoch-owned papers, when he is briefing foreign journalists. The Government learnt the danger of schmoozing with media moguls pretty quickly - Blair was embarrassed when it emerged that he had lobbied the then Italian Prime Minister, Romano Prodi, about an Italian television deal Murdoch was trying to clinch. This is not a love affair, it is a marriage of convenience in which both parties will use the other to their own advantage when they can and then dump them when they cannot.

Arguably, Murdoch has already won some concessions from the Labour government. Ministers rejected attempts to block his price-cutting tactics and the legislation on employment rights was watered down from the trades unions' original demands. But the Manchester United bid was a far more lucrative prize - and one that it was impossible for the Government to give. In fact, the perceived special relationship between Blair and Murdoch meant that the Government had to be even more clear than normal that the media mogul was not receiving special treatment.

The MMC's recommendation was the perfect solution for the Government. While most people had expected some sort of fudge with tough conditions imposed if the deal were to go ahead, in fact it concluded that it should be blocked outright because it would give BSkyB an unfair advantage in future sports rights negotiations. The judgement was so categorical that it would have been impossible for Stephen Byers to overrule it. Even BSkyB insiders admit that the language of the report was so "stark" that the Trade Secretary had no choice but to block the bid. Ministers could keep the fans happy while passing the blame in Murdoch's eyes on to the great and good of the competition panel. Some MPs think the result was so ideal that the MMC must have been second-guessing the Government in producing this outcome - certainly the members knew what the position of some ministers was. Chris Smith's Department for Culture, Media and Sport made clear in its evidence to the MMC that it did not believe the takeover would be in the best interests of football. Tony Blair also knew in advance of the announcement what exactly the MMC had concluded.

It was a classic New Labour solution to a New Labour problem, perfectly managed and perfectly executed. But the trials and tribulations of the Blair-Murdoch relationship are not over yet. The big battle is yet to come and that will be fought over Europe. The Prime Minister knows that it would be difficult - although not impossible - to fight a campaign to persuade the British public to vote in favour of joining the single currency in the face of outright opposition from the Sun. He also knows that it is unlikely - although not impossible - that the redtop paper will change its ardent line. The real test of Blair's mettle will be whether he presses ahead with a referendum irrespective of the line taken by the Murdoch press. And at the moment at least, all the indications are that he will.

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