Morgan Stanley hikes chance of WTO-style Brexit to 40%

LONDON (Reuters) - Investment bank Morgan Stanley has ramped up the risk of Britain and the European Union flopping onto World Trade Organization terms to 40% from 25%, after the UK signalled a willingness this week to walk away from Brexit talks.

FILE PHOTO: People take photos by the Morgan Stanley building in Times Square in New York City, New York U.S., February 20, 2020. REUTERS/Brendan McDermid

Negotiations have been thrust into chaos by UK Prime Minister Boris Johnson’s threat to tear up part of the divorce treaty he signed only last year.

“Although we still expect a deal in the end, the probabilities have shifted,” Morgan Stanley’s analysts said in a note on Friday.

“The risks are skewed to a harder outcome... bumping up the probability of our bear case of a WTO-style outcome to 40%,” they said, adding a delay in implementing any deal was also likely.

The chance of WTO crash out could be even higher if the UK government saw a significant chance of a close trade deal with the United States -- something seen as more likely if Donald Trump wins a second term as U.S. President in November.

Morgan Stanley has previously modelled that in a WTO outcome, the share of UK exports to the EU facing tariffs – at an average 4% – would rise from zero to around 60%, with other non-tariff related frictions such as quotas or embargoes also having a damaging impact.

In the context of a near 20% slump in the British economy due to the pandemic, the hit from a WTO Brexit would look modest at between 1.1% and 2% of GDP over the four-quarter period following the UK’s exit.

Nevertheless Morgan Stanley thinks a 'hard Brexit' would send the pound down to $1.15, roughly 10% from its current $1.28 GBP= level and cause a 20% plunge in British bank shares. A reasonable trade deal, meanwhile, could lift the pound to $1.40 and boost bank shares by 20-40%, the bank said.

Other institutions have also been rapidly revising their Brexit assumptions this week following the political drama.

Japanese bank Nomura has warned that the chance of a no-deal could be as high at 50-60% if relations continue to fracture, while ratings agency Fitch has made WTO terms its base case outcome and knocked 2% off its 2021 British economic forecasts.

Reporting by Marc Jones; editing by Thyagaraju Adinarayan and Louise Heavens