The Prime Minister's blunt warning was delivered to the chairman of BAe, Sir Dick Evans, and GEC's chief executive, Lord Simpson, at a private meeting on Monday evening.
Lord Simpson, who was ennobled by the Labour government, indicated yesterday that Mr Blair had spelt out in the clearest of terms that he would have preferred to have seen a cross-border merger that included French or German partners. DaimlerChrysler Aerospace (Dasa), which was in advanced merger talks with BAe until just before Christmas, said the BAe-Marconi deal would make horizontal European mergers "impossible and create an obstacle to European integration".
Sir Dick said: "The Prime Minister's views on this and other matters are very important to us."
But, despite a concerted effort to sell the merger to the Government and the City as a "win-win deal" that would benefit shareholders and accelerate the process of defence consolidation, shares in BAe and GEC fell by 14 per cent and 6 per cent respectively.
This cut the value of Marconi by pounds 700m to pounds 7bn and reduced the stock market value of the combined business to pounds 14bn.
Analysts said that apart from "deal fatigue", the shares had been hit by fears that the merger indeed spelt the end of further European consolidation, that the 30 per cent premium paid by BAe was excessive, and that the savings from the merger would go to customers rather than shareholders.
Sir Dick conceded that the merger would initially be seen as "threatening and an obstacle to making progress" by other companies. But he said that consolidation could best be driven forward if there were just one major player in each country. "The reality is that Europe can afford only one aerospace entity," he added.
The merger will create the fourth-biggest aerospace and defence company in the world after Boeing, Lockheed Martin and Raytheon of the US, with sales of pounds 13bn and pounds 33bn orders.
BAe said there would be cost savings of at least pounds 275m by the third year, which would lift earnings by 10 per cent. There would be job losses but BAe would not give a number.
Ken Jackson, general secretary of the AEEU engineering union, said the deal would secure thousands of jobs.
BAe is financing the deal with 1.17 billion new shares, a pounds 1.55bn cash payment to GEC and pounds 440m of convertible loan stock repayable over three years. Goodwill charged against profits could reach pounds 7bn if BAe treats the deal as an acquisition.
There was speculation about how Lord Simpson would spend the pounds 2.7bn cash pile the rump of GEC has. He rejected rumours GEC would bid for Racal Telecoms but indicated it hoped to do a big deal to strengthen its telecoms division.
Countdown to consolidation
January 1995: US approves $9bn Lockheed/ Martin Marietta merger.
May 1996: BAe and Lagardere of France form 50:50 missiles joint venture, Matra BAe Dynamics.
December 1996: Boeing announces $13bn takeover of McDonnell Douglas.
January 1997: French confirm that Aerospatiale and Dassault will merge.
December 1997: Raytheon acquires Hughes defence business for $9.5bn
April 1998: BAe pays pounds 269m for 35 per cent of Swedish aircraft maker Saab.
July 1998: GEC and Finmeccanica merge defence electronics arms.
July 1998: France reveals plan to merge Aerospatiale and Lagardere defence interests and float 20 per cent.
July 1998: Heads of six European countries back formation of single European aerospace and defence company.
December 1998: BAe indicates it is poised for $23bn merger with DaimlerChrysler Aerospace: GEC announces plans to demerge Marconi and intensifies talks with BAe.
January 1999: BAe and Marconi merge.