Facing growing opposition to the sale of a major water resource, Mr Howard announced his government would not give up its 13 percent stake in Snowy Hydro as planned.
He was quickly followed by the state Labor governments of New South Wales and Victoria, which said they could not go ahead with the sale of their respective 58 percent and 29 percent stakes in project.
An angry NSW Premier Morris Iemma, who had hoped to use the proceeds from the privatisation to improve social services in Australia's most populous state, said the sale would be "impractical" without federal participation.
"The prime minister has pulled the rug out from under the sale," he said.
Snowy Hydro straddles the border of NSW and Victoria and includes seven power stations, 16 major dams, 145 kms of tunnels and 80 kms of aqueducts. The project supplies nearly three quarters of the renewable energy in eastern Australia.
NSW Finance Minister John Della Bosca said the Mr Howard's decision served to "condemn it to a slow death."
"It needs anywhere between 300 million and half a billion dollars worth of capital over the next five years and the prime minister has left it with nowhere to go," he said.
The sale through a stock market float had been expected to raise between A$1.7 billion and A$3 billion (US$1.3 billion to US$2.25 billion).
The project was built over 25 years starting in 1949 by 100,000 workers from more than 30 countries and is widely viewed as one of the formative events of modern Australia.
Mr Howard said it was this symbolic aspect of Snowy Hydro that persuaded him to back down on its sale.
"There is overwhelming feeling in the community that the Snowy is an icon, it's part of the great saga of post world War II development in Australia," he said.
"I have been surprised by the level of public disquiet -- it's turned out to be much greater than I expected,” he said.
Opponents, who included former Prime Minister Malcolm Fraser and Oscar-winner actress Cate Blanchett, objected to the privatisation of a major water resource on the world's driest populated continent.
"Water's a scarce resource for the whole continent and to have its best use determined by a private company whose interest is profit for shareholders is not going to lead to the best answer," Mr Fraser said.
The decision was a shock turnaround for Mr Howard, who has sold off numerous state assets since coming to power 10 years ago and is still fighting strong public opposition to the planned sale of the government's 51 percent holding in telecommunications giant Telstra.
As late as Wednesday, Mr Howard had announced legislation to restrict foreign ownership of Snowy Hydro to a maximum 35 percent in a bid to assuage opposition to the sell-off, including among senior members of his own party.
His sudden about-face sparked renewed calls for him also to abandon the Telstra sale.