AUSTRALIA'S intelligence agencies may win far greater flexibility to use surveillance tools at home after an independent inquiry ordered by the Rudd government.

An intelligence review, confirmed in the federal budget, is likely to examine strict limits on how agencies that have been set up to protect against foreign threats can operate in Australia.

The $3 million review is due to be completed by the end of next year.

Last month, sources told The Age that a secret intelligence review driven by the Department of Prime Minister and Cabinet was preparing to recommend that defence intelligence be given powers to tap phones within Australia.

Also, officers from the Australian Secret Intelligence Service, the overseas spy agency, would be given significantly increased freedom to carry weapons and engage in ''paramilitary activities'' abroad.