Air New Zealand and Virgin Blue's growth aspirations on the Tasman appear to have been dealt a severe blow with the Australian competition watchdog rejecting a proposed alliance.

The airlines wanted to establish a second Australasian airline network to combat the combined juggernaut of Qantas and its fast growing budget arm Jetstar, which Air New Zealand chief executive Rob Fyfe warned would dominate the market if left unchecked.

Under the alliance, Air New Zealand and Virgin Blue, which flies as budget carrier Pacific Blue on the Tasman, would have co-ordinated fares, revenue management, schedules, capacity and routes.

However, the Australian Competition and Consumer Commission found that the alliance would reduce competition, affecting more than a million travellers a year.

The alliance would have controlled just over half the total trans-Tasman market, but Qantas did not oppose it.

ACCC chairman Graeme Samuel said while the alliance would provide the two airlines with a broader and more integrated network, the commission was not convinced that this necessarily created a more competitive environment than if Virgin Blue and Air New Zealand continued to operate independently.

Virgin Blue was a significant competitor to Air New Zealand and there are a number of trans-Tasman routes where the alliance would raise competition concerns, Mr Samuel said.

"These routes account for around one quarter of passenger traffic in the trans-Tasman market. More than a million passengers a year could be adversely affected if competition between the two airlines was removed, Mr Samuel said.

The alliance could provide some public benefits such as cost savings and efficiencies.

However, the commission was not convinced about the magnitude of these benefits, he said.

The decision has surprised Centre for Asia Pacific Aviation executive chairman, Peter Harbison.

The alliance was not as far reaching as the previously rejected merger between Air New Zealand and Qantas, he said.

"It doesn't seem to me to stack up all that well, frankly."

He believed the alliance would eventually be approved, with conditions, particularly for routes such as Dunedin, which would become a monopoly.

The commission's argument that Pacific Blue acted as a pricing "maverick" was baseless, Mr Harbison said.

In fact, Pacific Blue's fares fell halfway between Jetstar, Qantas and Air New Zealand, illustrating the airline's precarious position on the Tasman, he said.

Pacific Blue has already announced it will pull out of the domestic market next month.

The ACCC also failed to take into account the threat of entry of Australia's newest budget airline, Tiger Airlines, Mr Harbison said.

But opponents have hailed the decision and have called on New Zealand's Transport Minister Steven Joyce to follow suit.

A high powered group of Wellington interests estimated that the alliance could have cost the region's economy more than $100 million a year and at least 1600 jobs.

Wellington Employers' Chamber of Commerce president, Jo Bransgrove, said the alliance would probably have led to higher fares and fewer flights.

"We would expect the New Zealand minister of transport to make a similar ruling on this side of the Tasman," Ms Bransgrove said.

House of Travel retail director Brent Thomas said travellers would have more choice without the alliance.

Air New Zealand had already responded to competition with a new fare structure on the Tasman which competed at both ends of the market.

"That is already changing the way that people are booking," Mr Thomas said.

Air New Zealand and Virgin Blue have until September 24 to respond to the draft decision before a final determination is made later this year.

A Transport Ministry spokeswoman said a report would be presented to Mr Joyce next month.

- © Fairfax NZ News