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Smith decided the 2.5% pay rise should only be introduced from December, rather than backdated to September, contrary to the recommendation of an arbitration panel. The police federation said this meant the deal was effectively reduced to an annual rise of 1.9%.
Speaking on BBC Radio 4's Today programme, Blair said: "I think this is a mistake. I told her [Smith] that and I told her predecessor that. The reason it's a mistake is because not enough notice has been taken of the special nature of policing in the sense that police officers don't have the right to strike."
However, commenting on warnings from the police federation that it may be forced to call for the right to strike over pay, Blair said: "I don't believe my service will go on strike.
"The professionalism of my officers and the officers all around the United Kingdom is such that that will not happen, but I do not see it's necessary to get into an industrial relations problem."
The chief constables of Essex and Cambridgeshire today refused to publish a Christmas message sent to all forces by Smith, saying it would be inappropriate in light of the dispute.
In a bullish interview, Blair also said he had never "come close" to resigning in the aftermath of the fatal shooting of Jean Charles de Menezes. He insisted his decision to stay was not damaging the force.
"The reason I didn't is because the way the Met is now performing. The way its sickness rates are falling, the way its recruitment from minorities is rising, the way public confidence is policing is rising. I was appointed to reform the service and that is what is happening.
"I'm a bit of a limpet really. I did not at any stage consider resigning."
When it was put to him that a cabinet minister in his position would have had to quit, Blair replied: "That's because cabinet ministers can't stand negative publicity. I can just sit there, in the end, and get on with it."
He accepted the De Menezes shooting would be "remembered as the major disaster that occurred on my watch", but said he hoped his leadership would be "judged on the whole of my service".
He expressed his "frustration" about the way the controversy had obscured what he claimed was the Met's success in mirroring the "New York miracle" in dramatically cutting crime in London.
On the question of extending the pre-charge detention period, Blair repeated his support for a 42-day limit, which has come under growing attack from figures such as the former Lord Chancellor, Charlie Falconer.
"It's the investigators who are asking for this extension, not the lawyers. The lawyers get the product of the investigations. The investigators know how difficult it is," he said.
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