Large rates increases are being considered by the Northern Ireland Office to cushion the impact of water charges on household bills in the long term, the BBC has learned.
Mr Murphy says plans are in place to increase rates
However, the plan to increase regional rates has been vetoed by the Treasury which has accused the NIO of trying to "get round the rules".
Last week, the government announced the formation of a new company to replace the water service in the province.
It also announced households would begin receiving water bills next year.
However, a leaked letter written by Secretary of State Paul Murphy reveals there are major differences between the NIO and the Treasury on how to proceed.
Mr Murphy's confidential letter to the Chief Secretary to the Treasury, Paul Boateng, stresses the need to manage the phasing and timing of water charges.
The Northern Ireland secretary says proposals have been drawn up to make immediate increases in regional rates over and above the trends - so they can moderate the long term impact on household bills.
However, this has been veteod by the Treasury to Mr Murphy's obvious disappointment.
He rejects what appears to have been an observation by his Cabinent colleague Mr Boateng that the move was "a way of trying to get round the rules."
Mr Murphy's letter does make clear that he is not ruling out future privatisation of the water industry in the province.
He addresses the Treasury's desire that privatisation should not be ruled out in the medium term and says he is content with that position.
However he has ruled it out for the time being, not just because of public opposition, but because if the government was to attempt what he calls "a rushed privatisation now", they would not get good value for money.
But Mr Murphy makes clear this does not rule out privatisation in the future.
DUP deputy leader Peter Robinson, who obtained a copy of the letter, has accused the government of cynically trying to pull the wool over people's eyes.
"I am utterly appalled at the cynical game of playing with people's pockets that Paul Murphy proposes in this letter to his Cabinet colleague the Chief Secretary of the Treasury, Mr Paul Boateng," Mr Robinson said.
"The government's period of public consultation over water reform is quite clearly a facade.The government has made up its mind."
In a statement, the NIO said no decision had been taken on rate increases.
A proposal is due next month and there will then be a period of consultation before any final decision is taken.
General Consumer Council chief executive Eleanor Gill said it would prefer that the debate took place in "an open and transparent way".
"It does not help that we are dealing with this in this way because it adds to suspicion, and indeed fear," she said.
"What we are looking at is, perhaps, people who feel they are going to have to make a choice between bread and water."