LAKE Macquarie City Council officials were shocked and disappointed over the prospect of a merger with their Newcastle neighbours.
An Independent Pricing and Regulatory Tribunal report found Lake Macquarie council was "not fit for the future".
The report said the preferred option was for Lake Macquarie to merge with Newcastle.
It found that Lake Macquarie council "did not demonstrate its proposal to stand alone would be as good as or better than" a merger.
Mayor Jodie Harrison said the news was "disappointing for the city and its 202,000 residents".
"This recommendation does not reflect the wishes of our residents," Cr Harrison said.
"We want to reassure our community that delivering the services residents expect and rely on will continue."
Cr Harrison said amalgamation would "bring challenging times, not only for residents of the two local government areas, but also for the councils' staff and their families".
Lake Macquarie councillor Barry Johnston said he was "absolutely shocked" by the report.
The Baird government appeared to have set a course of no return.
"From what I've gathered, there's no way out of it," Cr Johnston said. "I'm struggling to accept it."
Cr Harrison said the council would "work closely with the Newcastle and Lake Macquarie communities to minimise adverse impacts on residents and businesses", if the final outcome was a merger.
Cr Johnston, an independent, said the push for a merger meant the Liberals had "ruined themselves as a political force in the Hunter for a while".
He said independents could be disadvantaged under a merged council.
Lake Macquarie council had shown itself to be politically stable, while a merged council could "tend to become politicised", he said.
The pricing regulator said Lake Macquarie council did not satisfy the criteria for "scale and capacity", but did meet "the financial criteria overall".
Lake Macquarie MP Greg Piper, a former independent mayor, was surprised that the council did not satisfy the criteria for scale and capacity, given it was "the sixth largest council in NSW".
"This finding only reinforces my view that this merger is about propping up Newcastle City Council at the expense of another council with an excellent record of financial management and efficiency," Mr Piper said.
The pricing regulator's report found reducing waste and red tape through mergers could stabilise council rates and find savings for better services and new infrastructure, a government statement said.
The report said "high-capacity councils" could "keep rates and charges at affordable levels".
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