The prospect of rising interest rates is usually a good thing for banking stocks. In fact, Lloyds Banking Group’s (LSE: LLOY) share price stability in 2022 owes much to rapid rate hikes.
But the FTSE 100 stock slumped on Monday on fears of sky-high interest rates. At around 44p per share, it was trading at three-week lows.
Does this share price drop represent a dip-buying opportunity? Lloyds shares certainly provide great value on paper. It trades on a forward price-to-earnings (P/E) ratio of 6.1 times and boasts an 5.4% dividend yield.
Why is Lloyds falling?
Lloyds shares are slumping as investors worry about the impact of rising interest rates. This has the potential to drive up bad loans as customers struggle to pay their debts. They also have the capacity to reduce demand for credit as consumer confidence dries up.
Rising rates might also cause the housing market to cool sharply. This is a particular danger for Lloyds given the importance of home loans to its profits. Around two-thirds of all loans and advances it gives to customers are mortgages.
Markets think the Bank of England might hike rates by a full percentage point by the end of the week. As well as helping to support sterling, rate rises are might be needed to reduce the boost to inflation that tax rates announced in Friday’s ‘mini budget’ could provide.
Future rate levels
| Lloyds’ share price | 44.3p |
| 12-month price movement | -3% |
| Market cap | £31.5bn |
| Forward price-to-earnings (P/E) ratio | 6.1 times |
| Forward dividend yield | 5.4% |
| Dividend cover | 3 times |
The Bank of England has raised its benchmark seven consecutive times since the end of last year. This in turn has turbocharged the bank’s net income, which rose by 12% between January and June (to £8.5bn).
Higher interest rates boost the difference between what banks charge borrowers and the rates they offer savers. This in turn boosts income.
However, Lloyds’ sinking share price reflects fears that rapid interest rate increases could now become a problem. Expectations are rising that levels will be raised to 3.25% this week, up a full percentage point from last week’s meeting.
Meanwhile bets are increasing that interest rates will top 6% over the short-to-medium term.
High risk
On a positive note for Lloyds, I think mortgage lending will remain solid in spite of interest rate increases. Ongoing government support for first-time buyers — allied with proposed stamp duty cuts in the mini budget — should support the housing market.
But the outlook is highly uncertain, of course. And the bank is still in my opinion likely to endure heavy weakness elsewhere. It made bad loan provisions of £377m in the first half. And I think more heavy charges could be coming.
Given the prospect of a long and severe UK economic downturn and Lloyds’ lack of overseas exposure, I’m happy to avoid buying the bank today.
