Australia's competition watchdog says more than a million passengers a year will be worse off if Air New Zealand and Virgin Blue are allowed to join forces.
The two companies want to collaborate on trans-Tasman routes to compete more effectively against Qantas and its subsidiary, Jetstar.
But in a draft decision released on Friday the Australian Competition and Consumer Commission (ACCC) says it wants to reject the proposed alliance because there will be less competition and therefore higher prices.
Commission chairman Graeme Samuel says there would be just two competing sides - Air New Zealand and Virgin Blue against Qantas and Jetstar.
Mr Samuel says that rejecting the alliance will keep three aggressive, determined competitors, which in turn will keep prices low.
A few weeks to appeal
The airlines are seeking regulatory approval on both sides of the Tasman for the co-ordination of routes, pricing, revenue management and schedules as part of a codeshare agreement.
They now have a few weeks to convince the ACCC to reverse its draft decision.
On Thursday, United States authorities, in a preliminary ruling, rejected Virgin Blue's proposal to form an alliance with Delta Air Lines on flights between Australia and the United States.
