Brexit will cause protracted political and economic uncertainty, says Morgan Stanley

The UK’s decision to leave the European Union will lead to profound and protracted political and economic uncertainty, Morgan Stanley said on Friday.

This in turn will lead to a weaker pound, pushing inflation up and denting growth, the bank said.

In terms of the political impact, it said the focus will be on whether the Prime Minister David Cameron and the Conservatives can maintain a working majority in parliament.

“Further down the line, we see a heightened risk of a second Scottish independence referendum.”

As far as the economic impact is concerned, Morgan Stanley said: “First it will hit sterling, as uncertainty reduces non-residents' appetite for UK assets against the background of the UK's record current account deficit.

“Second, it will hit growth, as firms hold back on investment, and households increase precautionary savings. Longer term, we expect a less open and more volatile economy, with reduced inflows of capital and labour, and a lower rate of potential growth.”

MS reckoned the MPC would have an easing bias, given the risk of low inflation from weak growth. It argued the MPC would be slow to act on rate cuts, but would stand ready to intervene in a case of disruptive market developments, particularly FX and gilts.

“In a 'civilised divorce' scenario, where the uncertainties are progressively reduced and the economy avoids recession, we see the MPC on hold. In an 'acrimonious divorce' scenario, where the uncertainties interact and amplify each other, we see the economy in a referendum recession by year-end. We expect this to trigger a cut in rates to 10bp, another £50bn tranche of QE, and easier fiscal policy, including the possibility of a radical helicopter money experiment.”

The bank also sees a hit to Eurozone growth and heightened political risks.

“Our global team sees negative spillovers, particularly from further USD strength, which could put the global economy into the recession danger zone.”

On trade, MS said the Leave vote will result in the UK having worse access to the single market than it has at present.

“The reassertion of national control over borders and laws, which the Leave side has been promising, will make it difficult for a eurosceptic UK to secure broad access to the single market. At least in the existing Swiss and Norwegian precedents, access to the single market has come with acceptance of free movement and EU regulations.

“We also think that negotiations will be complicated by the EU's desire to avoid a precedent which might increase the risk of further exits.”