The Australian Government has tried to counter the threat of Islamic extremism by investing in mentoring and educational initiatives. Fearful of the potential for “home-grown” extremism, especially after the July 2005 London attacks, the Australian authorities seek to counter the narrow-minded narrative of extremism by sponsoring “moderate Islam”. This approach is aimed at presenting a counter-ideology to Islamism, and has had some success. But it neglects the broader context of Muslim experience which is marked by socio-economic under-privilege and political alienation. These experiences marginalise Australian Muslims and make them vulnerable to extremist ideas. This pattern is most evident among the youth, whose sense of self is still in flux. Furthermore, the state’s sponsorship of “moderate Islam” puts Australia on a questionable path as it chips away at the principle of the separation of state and religion and makes moderate Muslims vulnerable to accusation of “betraying” Islam by the more radical elements in the Muslim community. This paper argues that efforts by the Australian Government to counter radicalisation are hindered by a range of political, cultural and socio-economic factors and analyses these factors in the light of historical, ethnic, cultural and social conditions relevant to the Muslim community in Australia.