Prescott ‘told councils to invest for high interest’

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Official guidance sent out by the office of the then deputy prime minister in 2004 stated that councils should "seek the highest rate of return".

Local Government minister John Healey today dismissed the claim, saying that the full advice made plain that town halls should only choose investments that were "consistent with proper levels of security and liquidity".

The advice also stressed that "priority" should be given to how safe the money would be and how easily it could be withdrawn.

Mr Healey pointed out that the advice had been to spread risk by investing in several different banks. An official list of approved banks had been withdrawn in 2003 so there was no question of Whitehall endorsement of specific Icelandic banks, he added.

But Tory shadow minister Eric Pickles demanded new guidelines and that the "advice must be re-written immediately".

A Local Government Association spokesman said: "Councils have followed advice to the letter to spread risk and place deposits in banks with a decent credit rating and interest rate."