Mr Howard said action was being taken against those responsible |
PM John Howard, who is trailing Labor rival Kevin Rudd, said the Liberal Party had not authorised the leaflets.
Distributed in a key Sydney seat, they purported to be from an Islamic group which thanked Labor for its sympathy towards the Bali nightclub attackers.
Those involved faced expulsion from the Liberal Party, officials said.
Both party leaders have been campaigning hard ahead of Saturday's election. The prime minister is seeking a fifth term in office but polls indicate Mr Rudd is maintaining a sizeable lead.
The BBC's Nick Bryant, in Sydney, says that this kind of scandal is just about the last thing Mr Howard's beleaguered party needs.
'Unjustly sentenced'
On Wednesday, Liberal Party members were caught distributing leaflets purporting to be from an Islamist group in the key Sydney marginal of Lindsay.
In the leaflet, which carries the Labor Party logo, a fake organisation - the Islamic Australia Federation - applauds Labor for supporting Islamic extremists.
It refers to the men imprisoned for the 2002 nightclub bomb attacks in Bali, which left more than 200 people dead.
"We gratefully acknowledge Labor's support to forgive our Muslim brothers who have been unjustly sentenced to death for the Bali bombings," it said.
Labor supported the building of new mosques, the leaflet added, thanking the party for backing the entry of controversial cleric Sheikh Taj el-Din al-Hilali - who likened scantily-clad women to uncovered meat.
'Unfair and dishonest'
Mr Howard said that this type of material should never have been distributed.
"It was not authorised by the Liberal Party, it is no part of our campaign, it was wrong and unfair and dishonest for any pamphlet to be distributed suggesting that the Labor Party was sympathetic to the Bali bombers," he said.
Mr Rudd has urged the Liberal Party to clarify who knew about the leaflets.
"This says everything about the desperate and desperation politics on the part of the Liberal Party on the eve of the election," he told Australian radio.
The issue has been referred to the Australian Electoral Commission and Labor has asked it to investigate whether the group acted illegally by appealing to anti-Muslim sentiment.
President of the Australian Federation of Islamic Councils Ikebal Patel told ABC radio that while election campaigning to date had been "fairly good" on the issue of migration, the use of the flyers was "quite despicable".
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