Sue Essex, minister for finance, local government and public services, has written to leaders, chief executives and finance directors ordering them to limit council tax increases to 'around 5%', or to increases in standard spending assessment.
In the letter, Ms Essex says that in addition to a 3.5% growth in funding under the settlement, local government will benefit from increases in the deprivation grant and revenue from the local authority business growth incentive scheme.
'I have made it clear I believe this is a fair settlement,' she said.
'In the meantime I have asked my officials to provide advice on arrangements for possible implementation of the powers available to me to restrict budget increases in 2005-06.'
Chris Freegard, managing director of Newport City Council, said he had been 'saddened' to receive the letter.
'One of the features of working in Wales is the good relationship between the assembly government and local authorities,' he said.
Council tax increases in Wales averaged 4.6% last year, compared to an English average of 5.9%.