Britain's recovery is secure but Brexit uncertainty will weigh, Morgan Stanley says

The recovery in Britain's economy is on track, but it will grow more slowly next year as the tighter fiscal purse strings and monetary policy stance leave their mark and uncertainty about the outcome of the UK's referendum clouds the outlook, Morgan Stanley expected.

The biggest change in the market backdrop in 2016 was to be a sharp rise in the year-on-year rate of inflation, as the drop seen in the second half of 2014, as oil prices collapsed, dropped out of the calculations.

That would see the headline rate of consumer prices move back above 1% as quickly as the first three months of the year.

At the 'core' level, the cost-of-living would jump past 2% in the second quarter of 2016, the broker's UK economics team predicted.

"We think the UK reflation story of a tighter labour market driving rising pay and domestic inflation is working. However, it will be a slow burn.Ample supply from migration and the rising retirement age, recovering productivity and weaker growth will likely mute domestic reflation, keeping pay growth <4% year-on-year," Morgan Stanley told clients in a research note dated 7 December.

So, unless the data or the timing of the Brexit referendum - which they had penciled in for September 2016 - prevented it, the first hike in Bank Rate would arrive in May 2016, they said.

Under their most pessimistic scenario, Britain opted out of the European Union even as weaker global trade and a sharp tightening in financial conditions hit the economy.

"We would expect a sharp slowdown in growth, as a result of high uncertainty, reflecting economic uncertainty over the future of the trading relationship with the EU as well as political risks over a possible acceleration in the succession to Cameron and a second Scottish independence referendum."

Making matters worse, inflation would rise as sterling weakened - leading the Bank of England to hold-off from raising rates until 2017.

Should their most rosy scenario play out, then that would see faster rate hikes in 2017.