The P-7's competitors had been Boeing's modified B757 and McDonnell Douglas' modified MD-90. Lockheed was announced by the USN as the winner in October 1988, and the UK had, in fact, stated it would buy P-7 instead of modernizing the MR2... until the USN canceled that program in 1990.
While I know in general terms what was going on in the late 80s I don't know if there was an endorsed requirement to replace MR2 at that time, although as you say there was an aspiration.
What did happen was a lot of piecemeal upgrades were endorsed, which gave the impression of stability and the MRA requirement being fully satisfied, but very often R&D was not backed up with development and production. On other occasions, companies saw the problems accumulating and committed private venture capital. For example, the limitations of the primary radar were recognised and the design review for the replacement was held on the day Margaret Thatcher resigned (!), but never used. Colour displays went ahead instead, which to me is back to front. Lots of indecision at the time, for whatever reason. At any one time there would be literally hundreds of ongoing tasks to tweak the old girl, few properly funded. Put them altogether and rationalise, and what popped out the other end is a new aircraft, not an upgrade.
I also recall there was much annoyance within the Treasury at Nimrod procuring a major new secure comms systems, at many tens of millions (lots in those days, for a small fleet), but as soon as all the kit was delivered deciding not to bother fitting it. They threw that one in the RAF's face for many years after that, every time they asked for MPA money. The infamous Staff Requirement 6676. Of course, the RN didn't help matters by specifying the same kit for Merlin, so keeping the pot boiling!
The money spent on the eventual 1996 contract is, in many eyes, just one example of many wasted spends. Treasury people tend to hang around in post for many years and they have long memories. The Post Project Evaluation report would be interesting reading, in a Yes Minister kind of way. It definitely shouldn't start in 1995. More like 1980-ish, when initial funding was committed to updating the forthcoming MR2.