CANBERRA (Reuters) - A fake letter linking Muslim extremists to Australia's opposition Labor Party and blamed on conservative supporters on Thursday entangled Prime Minister John Howard in a damaging row two days before a national election.

The flyer, purporting to come from a non-existent Islamic Australia Federation, was dropped in letterboxes in a key Sydney seat and painted Labor as sympathisers of three men on death row in Indonesia over bombings in the tourist island of Bali in 2002.

Howard's Liberal Party said it had suspended two unidentified members over the hoax. Both parties referred it to Australia's electoral commission.

"I condemn it, I dissociate myself from it. It is no part of my campaign and the party has acted promptly to deal with it," Howard told local radio.

The furore follows controversy about small numbers of Islamic extremists in Australia's Muslim community. Far right politician Pauline Hanson, who a decade ago called for an Asian immigration ban, is campaigning this time for a freeze on Muslim migrants.

"My first reaction was 'oh no, not again, not the Muslims again'," Australian Federation of Islamic Councils President Ikebal Patel said.

"At such a late stage in the election process to bring something like this up in a fake flyer going around is really quite despicable," he said, demanding a police investigation.

The minority Australian Democrats accused the government of resorting to "bigotry and fear-mongering" to stave off defeat and peg back a year-long lead by Labor in opinion polls.

"Instead of standing up against prejudice and ignorance, the Liberal's have regularly turned a blind eye or given knowing winks to dog-whistling that plays on fear regarding Muslim Australians," Democrats Senator Andrew Bartlett said.

"OUTRAGEOUS": HOWARD

The bogus pamphlet applauded Labor for supporting bombers "unjustly" sentenced to death and praised the party for allowing a controversial Muslim sheikh, who compared immodestly dressed women to uncovered meat, to live in Australia.

"We gratefully acknowledge Labors (sic) support to forgive our Muslim brothers who have been unjustly sentenced to death for the Bali bombings. Ala Akba (sic)", or God is Great, it said.

The damaging row looked likely to overshadow a televised address to the nation by Howard later on Thursday.

Howard said the flyer was "wrong, unfair and dishonest", and it was "outrageous" to link Labor to the Bali bombers, blamed for the deaths of 88 Australians among 202 victims.

"I knew nothing about this until I was informed that it had occurred and can I say that the Liberal Party organisation has acted with lightning speed," he said.

The western Sydney seat is held by retiring conservative MP Jackie Kelly, a former minister and close confidante of Howard, who condemned the flyer and said she knew nothing about it.

"I think its intent is to be a send-up, but it obviously hasn't worked," Kelly told Australian Broadcasting Corp. radio.

With Labor needing to pick up 16 seats for victory, Kelly's seat may prove vital in an election likely to rest on outer Sydney electorates where many home owners have been hurt by successive interest rate hikes.

Labor's Rudd said Howard, 68, who is seeking re-election for a fifth term, must explain who in his party had been aware of the flyer, accusing him of "desperate and desperation politics".

"This is extraordinary. Their negative fear campaign is now being run out to people's letter boxes," he said.