10-year gilts, coming to a council near you?

With the end of a period of cheap loans, will councils turn to the money markets for funding?

Occupy Bristol camps in front of Bristol Council. Credit: Getty

Councils across the country are expected to look again at the possibility of issuing bonds to raise money on the capital markets, now that a five-month deferral of an interest-rate rise has come to an end.

The Public Works Loan Board (PWLB) is a government body which exists to facilitate cheap loans from central government to councils and local authorities across England and Wales. Run by the Debt Management Office, it has, until now, had the ability to offer councils money at 20 basis points – or 0.2 percentage points – above the rate the government gets from the money markets.

Last summer, however, George Osborne raised the rate of interest charged by 100 basis points, in a move which was aimed at saving the Treasury up to £450m a year by 2014-15. At the same time, however, a separate reform of council house funding introduced by the last government left a £13bn hole in accounts.

The latter reform, to the Housing Revenue Account (HRA), was introduced to end a redistributing element in the way council houses were funded. Previously, revenue from the rent and sale of council houses was distributed between all councils, regardless of where it came from, which greatly reduced the incentives to build any more (it created a classic free-rider problem; councils would get housing revenue no matter how many they built, so why should they build any at all?). The shake-up ended that, but also left a £13bn debt to repay, which still exists.

The result of this was that the plan to boost the interest rate was put on hold for five months for the councils affected by the HRA change, to give them time to pay off a bit of their debt. That deferral has come to an end, and councils will shortly have to begin scrambling for a better source of credit.

The most likely outcome is that they will return to the plans, originally mooted last September, to start issuing bonds on the open market. As Tom Symons of the New Local Government Network said at the time:

This will be a blip, but five months down the line councils should still be able to borrow more cheaply in capital markets than with the PWLB.

If council bonds are seen as effectively backed by the UK government, they could be very cheap indeed. The current rate for 10-year bonds is just 2.27 per cent, meaning that creditors are paying the government to loan to them. Councils are unlikely to be that privileged, but they may still find themselves wondering why they hadn't made that move sooner.