Between 30-40% of households on lower incomes will face difficulties paying their mortgages, with average rates on some fixed-rate products now topping 6%, the bank estimates.

The country's mortgage market was plunged into chaos last month, after then-finance minister Kwasi Kwarteng unveiled plans promising billions of pounds of unfunded tax cuts, causing market turmoil and a scramble to raise mortgage prices.

New finance minister Jeremy Hunt said on Monday the government would raise 32 billion pounds a year in extra revenue, as he sought to restore investor confidence in the country's fiscal credibility.

Despite some calm being restored to markets, the Morgan Stanley note said ahead of Hunt's announcement that it did not expect mortgage rates to come down quickly.

Higher home loan pricing will pressure borrowers and the banks who lend to them, Morgan Stanley said, leading it to downgrade the country's biggest mortgage lender Lloyds from 'overweight' to 'equal-weight'.

The U.S. investment bank said it now only recommends buying shares in NatWest among British banks, citing its lower credit risk profile.

Britain's mortgage market - which has boomed since the early days of the COVID-19 pandemic - is likely to flatline in 2023, the note added, as the bank downgraded its forecast from 2.5% mortgage growth to zero.

Not all bank analysts have a bearish view. British banks are oversold, analysts at Berenberg said in their own note on Monday, adding that a boost to profits from rate rises would likely offset a plausible increase in loan losses.

Britain's banks report third-quarter earnings next week, with HSBC first on Tuesday, followed by Standard Chartered and Barclays on Wednesday, Lloyds on Thursday and NatWest on Friday.

Investors are already questioning whether banks' risk models are up to the task of identifying which home loans may turn sour when unemployment is low but household budgets are nonetheless being squeezed, Reuters reported last week.

The country's bank shares have swung wildly since the Sept. 23 fiscal announcement, with Lloyds down 10%, against a 1.7% fall in the benchmark FTSE 100 index.

(Reporting by Iain Withers and Lawrence White, Editing by Bernadette Baum)

By Iain Withers and Lawrence White