Lloyds Banking Group‘s (LSE:LLOY) share price see-sawed following the Bank of England’s (BoE) meeting yesterday (6 February).
The FTSE 100 bank surged following the midday rate announcement but sharply retraced shortly afterwards. In the end, it rose on the day but market sentiment is clearly fragile.
I can’t say I’m surprised. There’s plenty in the BoE’s rate decision and accompanying commentary that I feel could spook investors.
Economic gloom
Before we get to the interest rate cut and its implications for Lloyds, let’s look at the central bank’s latest growth forecasts.
There’s no way to paint this in a good way. The BoE’s latest estimates for Britain’s economy are pretty grim.
The central bank now expects UK GDP to expand just 0.75% in 2025. That’s HALF the rate of growth that had been predicted as recently as November.
That wasn’t the BoE’s only worrying prediction either. Raising fears of dreaded ‘stagflation’, it estimated Consumer Price Inflation (CPI) will spike again to 3.7% in quarter three.
That’s up from 2.5% in December, and approaching double the BoE’s 2% target.
A combination of weak economic growth and resurgent inflation could wreak havoc on Lloyds. As well as impacting credit demand, the Black Horse Bank could also face a significant rise in loan impairments.
Lloyds’ is already struggling to generate sales growth — indeed, net income actually dropped 4% in quarter three, to £4.3bn. Things could get much worse if the economy cools again.
Slashed interest rates
There’s also the possibility that interest rates could plummet in the short-to-medium term as the BoE tries to stimulate growth.
Falling rates are a double-edged sword for banks. On the one hand, their economic benefits can boost consumer demand. In particular, they can lead to a resurgence in the mortgage market, an area in which Lloyds is the clear market leader.
However, reduced rates can also pull net interest margins (NIMs) — the difference between the interest banks charge borrowers and what they pay savers — through the floor.
This key level of profitability is already alarmingly thin over at Lloyds. In the third quarter its NIM was 2.94% and falling, down 19 basis points year on year.
Judging from this week’s meeting, BoE ratesetters are becoming much more eager to cut rates than just a few months ago.
To the market’s surprise, two members of the Monetary Policy Committee (MPC) voted for a half-a-percent rate cut, including the previously hawkish Catherine Mann.
The other seven voted for a 0.25% reduction, resulting in that eventual cut to 4.5%.
As I say, lower interest rates can have benefits as well as drawbacks for Lloyds. But they clearly add another layer of danger.
A risk too far?
Some could argue that these hazards are baked into the low valuation Lloyds shares command. At 63p, they trade on a forward price-to-earnings (P/E) ratio of 9.1 times.
I’m not so sure, though. The risks to the bank’s profits are severe. And especially when one also considers other dangers, like growing market competition and a Financial Conduct Authority (FCA) probe into car finance that may trigger huge financial penalties.
Right now, I’d rather search for other cheap UK shares to buy.
This post was originally published on Motley Fool
