Former senior intelligence analyst Andrew Wilkie said Prime Minister John Howard created a mythical threat by dropping ambiguous references in intelligence reports, a practice which prompted him to resign in March when the war began.
"The government lied every time it skewed, misrepresented, used selectively and fabricated the Iraq story ... The exaggeration was so great it was pure dishonesty," Wilkie, formerly of the Office of National Assessment (ONA), told the inquiry.
The ONA is equivalent to the US National Security Agency.
"Key intelligence assessment qualifications like 'probably', 'could' and 'uncorroborated evidence suggests' were frequently dropped. Much more useful words like massive and mammoth were included," he added.
Wilkie's latest remarks are his strongest yet against Howard's administration, although he has made numerous attacks on the Australian PM.
With no evidence of biological, chemical or nuclear weapons, Howard nevertheless maintains he made the right decision to send a 2000-strong force to the Gulf despite initial public qualms.
"We didn't ask that the intelligence material be distorted. I and my colleagues made a bona fide judgment based on the assessments that existed at the time," Howard told Australian radio on Friday.
Wilkie believes Iraq had a disjointed weapons of mass destruction programme at best and that the United Nations should have been given more time to search Iraq.
"The government was prepared to deliberately exaggerate the … terrorism threat so as to stay in step with the United States"
Former intelligence analyst
He said the Australian intelligence community was sometimes biased by US intelligence, government pressure and politically correct intelligence officers.
"The government was prepared to deliberately exaggerate the … terrorism threat so as to stay in step with the United States," Wilkie said.
Former UN weapons inspector Richard Butler told the same inquiry on Friday that the tiny amount of specific hard intelligence was mostly accurate.
However, Butler said the more voluminous speculative intelligence, such as intercepted messages and pictures taken by spy planes, tended to be less than 50 percent accurate.
Butler led the UN weapons inspection team in Iraq between 1997 and 1999.
The Australian inquiry, some of which will be held in secret because of the confidential nature of some intelligence, is due to report back to the conservative government in December.
The Australian parliamentary hearing parallels an inquiry into the information the British government used to make its case for invading Iraq and toppling Saddam Hussein.
UK Prime Minister Tony Blair and Defence Secretary Geoff Hoon are due to give more evidence next week at an inquest into the suicide of weapons expert David Kelly, who was caught up in a row over the prime minister's case for war with Iraq.