By Michael Shields
ZURICH, July 1 (Reuters) - A skirmish over stock market access between Switzerland and the European Union risks escalating into a broader political battle over sovereignty that could do lasting damage to relations.
After months of tensions, the bourse row came to a head on Monday when Brussels refused to extend recognition of Swiss market regulation, effectively banning EU-based banks and brokers from trading on Swiss exchanges.
The step punished Bern for failing to endorse a treaty negotiated over 4-1/2 years that would have non-EU member Switzerland routinely adopt changes to EU single market rules and provide a more effective way to settle disputes.
Switzerland retaliated by banning trading in Swiss stocks on EU exchanges, which normally generate around 30% of the volume in Zurich-listed shares.
The EU's powerplay could stiffen Swiss resistance to signing the draft treaty, which has raised concerns across the political spectrum about infringement of Swiss sovereignty.
Both sides say they remain open to talks, but no quick deal is in sight with Switzerland's biggest trading partner.
Swiss parliamentary elections on Oct. 20 complicate matters, and with Brexit also looming on Oct. 31 Brussels is loathe to be soft on the Swiss for fear of encouraging British hopes for favourable divorce terms.
Gerhard Pfister, leader of the centrist Christian Democrats in the four-party Swiss coalition government, told the Blick newspaper at the weekend that several roadblocks remained.
"The blockade will be lifted in a year at the earliest," he predicted, citing questions over the role of EU courts in deciding on Swiss rules to protect wages and on whether EU citizens in Switzerland get the same rights as at home.
Swiss labour unions and their Socialist allies in government have been dead set against watering down labour rules, which protect Europe's highest wages against cut-rate German plumbers, French electricians or Italian roofers on short-term jobs.
Winning labour over for a deal remains a main hurdle before European Commission President and self-declared Swiss ally Jean-Claude Juncker's term is set to end on Oct. 31.
Anti-Swiss sentiment is on the rise in the EU, as well, over perceived Swiss foot-dragging.
EU members in central and eastern Europe are upset that, amid the stock market row, the Swiss parliament has held up a 1.3 billion Swiss francs ($1.3 billion) "cohesion payment" to reduce economic and social disparities in the bloc and seen as the price of Swiss admission to the single market.
With politicians about to head into summer breaks, efforts to revive talks may have to wait until September.
FACTBOX-Who stands to lose if Swiss-EU treaty talks fail
($1 = 0.9831 Swiss francs) (Reporting by Michael Shields; Editing by Mark Potter)