UK debt on the brink?

We recently posted a piece on the fact that bearish “doomsday” scenarios were not just a view held on the kooky fringe, but were in fact increasingly being factored in to mainstream economic scenarios by some of the big banks and financial institutions. 

The latest to join the fray is Morgan Stanley and this time the object of their worries is the UK.  A recent Morgan Stanley report to clients reckons that Britain is not only at risk of outright sovereign default, but that it is likely to be soon.  Like, 2010-soon.  MS highlights the risk that high grade corporate debt could command a lower risk premium (ie lower interest rate) than government debt, a hugely bearish prognosis for the government debt metrics. 

It’s funny though.  Once again in typical big-bank-doesn’t-want-to-sound-too-crazy fashion, the consequences don’t really seem to match the prognosis.  What I mean is, MS only reckons that a debt crisis would see “some of the ratings agencies remove the UK’s AAA status”.  The bank also says that an extreme fiscal crisis would lead to “severe” Sterling weakness of, wait for it, 10%!  Wow, scary stuff.  Now I know Sterling has already been hammered in recent times, but in a full-blown debt crisis Sterling will get annihilated by much more than just another 9 pence to the Euro. 

In another apocalyptic (not) prediction MS reckon UK bond yields could rise by 150bp.  They should be so lucky.  A debt default situation would probably take longer bond yields toward, if not into, double digits and squeeze the life out of mortgage and long term capital markets. 

The capital flight would be huge and it would also send enormous quakes through global financial markets. 

One wonders if MS really believes the UK can default in 2010 or whether, like SocGen a few weeks back, they are putting something out to their clients so that at least they can say they covered that base when all goes pear-shaped? 

As Human Action said recently regarding the bearish SocGen “scenario”,

“the overall point… is that big banks are seriously considering the not-so-nice outcomes of this global government debt binge.  That the big conservative behind-the-analytical-curve banks are now cottoning probably means that we are closer to a very bearish outcome than many realise.”

You can read the Morgan Stanley piece below.

Morgan Stanley Tougher Times 2010 R1130TD