Limits to Competition

A peculiar leader in The Guardian of 26 April 2007, When Low Prices Come a a Cost. Commenting on the OFT's recent investigation of price fixing in tobacco and the Competition Commission's emergent thinking on BAA (holder of exclusive rights to several UK airports), it notes how while competition law enforcement might reduce prices and increase consumption, there is a doubtful public interest in encouraging smoking and more flying. It suggests that sometimes competition enforcement that is blind to the negative spillovers of the market being regulated might need tempering. Three responses are possible:
1) Rubbish: it is up to other regulatory fora to deal with the externalities directly.
2) Agreed, and the solution is to give the competition authority a degree of prosecutorial discretion where it can choose not to take a case where the overall balance of the result is negative - so prosecute a cartel in vitamins but not one in the tobacco market. (But a weak line of argument.)
3) Agreed, bu in UK competition law the Competition Act 1998 provides for how this kind of issue should be dealt with. Schedule 3, Paragraph 7 Competition Act 1998 empowers the government to determine that the applicaion of competition law to a given sector can be excluded when 'exceptional and compelling reasons of public policy' exist.
(a) An existing exclusion exists in the context of firms involved in the the development of 'complex weapons', the Competition Act 1998 (Public Policy Exclusion) Order 2007.
(b) The government appear to be considering an exclusion for off licence shops to allow them to compete less aggressively as a means of reducing alcohol consumption, or to allow supermarkets to collude to agree to stop heavy discounts. (Can anyone find some of the Home Office or Dept of Health studies upon which these proposals are based?)

Two questions about this legal basis:
(i) is an exclusion compatible with EC competition law? (cf. Article 3, Regulation 1/2003, internal market laws, Arts 3(1)(g), 10 and 81 EC).
(ii) can the government really secure an exclusion to allow alcohol retailers to restrict competition? Is public health comparable to military security as a public interest ground?