Qantas and BA said on Tuesday they were in talks to form a dual-listed airline, a latest move in an industry desperate to slash costs as recession-hit businesses and tourists curb travel.

In Europe, Germany's Lufthansa is vying with Air France KLM to secure a tie-up with bankrupt Alitalia, and plans to buy Austrian Airlines, while in the United States, Delta Air Lines is trimming capacity.

But Australia's Labor government, which traditionally relies on trade unions for its power base, threatened to slam the door shut if it felt Qantas was effectively being taken over.

Our bottom line is the 'Flying Kangaroo' remains majority Australian-owned and based," Treasurer Wayne Swan told reporters.

Ministers flagged any deal would have to meet the national interest and should not amount to a takeover of Qantas.

"Were that to be the case, the government would certainly not support it," Transport Minister Anthony Albanese told state radio.

Qantas shares last traded up 4.4 per cent at A$2.35, off a 3-week high hit earlier. The broader market rose 0.2 per cent.

"I would support that type of (merger) move," said Angus Gluskie, of White Funds Management which owns Qantas shares, citing a need to cut costs given falling demand and the risk of global recession.

Airline industry body IATA has warned the airline industry could lose more than $5 billion this year.

But another Australian fund manager, who declined to be identified, said Qantas was unlikely to yield much more cost savings from a merger with BA than it could already achieve through its current code-sharing partnership.

Others said it was too early to comment without knowing the terms of any deal.

"In principle, there's nothing wrong with it. The issue is what's the merger ratio. Does it reflect the value of the Qantas franchise, and how big are the synergies?" said Paul Fiani, managing director of Integrity Investment Management.

Fiani, then at UBS Asset Management, was one of two fund managers who scuppered an $11 billion private equity bid for Qantas last year.

The other major shareholder who opposed that deal, Balanced Equity Management, declined to comment. On Tuesday, BA shares surged as much as 17.5 per cent after it said it was exploring a tie-up with its fellow OneWorld alliance member. BA once owned 25 per cent of Qantas, but sold out in 2004.

POSSIBLE IBERIA TIE-UP

BA, whose 1.8 billion pound ($2.7 billion) market value is only a fraction smaller than Qantas', also said merger talks were continuing with Spain's Iberia to form the world's third-largest airline.

The value of announced mergers in the airline industry has already risen 10 per cent from last year to a record $20 billion from 113 deals, according to data compiler Dealogic.

A three-way tie-up between BA, Iberia and Qantas would create the world's biggest airline, with combined scheduled passenger kilometres flown of almost 270 billion a year, comfortably overtaking American Airlines' AMR 222.8 billion.

Qantas did not mention Iberia in its short statement and declined to make any further comment.

Analysts said the move was in line with BA's strategy of taking a lead in industry consolidation to put itself in better shape to deal with increasingly tough times.

For Qantas, a merger would open up the European market.

"It will be a partnership that is mutually beneficial. It does help Qantas ... get entrenched in that European market more effectively," said Derek Sadubin, chief operating officer of the Centre for Asia Pacific Aviation, a Sydney-based consultancy.

Analysts said a three-way combination looked a long way off, however, given that talks with Iberia were first announced in July and have stalled on worries over BA's pension deficit.

"I would see the priority of things being the Iberia merger talks and the Iberia/American anti-trust immunity before any deal is done with Qantas," said NCB analyst Neil Glynn.

British Airways, Iberia and American Airlines said in August they had filed for US antitrust immunity in order to cooperate commercially on flights between North America and Europe.

Under Australian law, Qantas, the world's 10th largest airline by market value, cannot be majority owned by foreigners and must maintain its headquarters and its stock listing at home.

Australia's pilots and transport workers' unions, which opposed last year's bid, pressed for keeping jobs in Australia.