Like most of the financial sector, shares in Lloyds (LSE: LLOY) have struggled since the UK’s decision to leave the European Union at the end of June. Indeed, unlike the rest of the market, which has quickly snapped back, shares in Lloyds and other financials have languished, and five months on from the vote Lloyds’ shares are still a fifth below their pre-Brexit levels.  

However, over the past three months, the shares have been grinding higher as sentiment towards the bank steadily improves. And as we head towards the new year, shares in Lloyds could be set for a strong rally that could take them back above 60p and put them on the course to return to 70p. 

Charting a course to 70p

Lloyds’ shares have come under pressure during the past few months as City analysts have become increasingly concerned about the lender’s prospects. Analysts are expecting a 16% decline in earnings per share this year for the bank, followed by a contraction of 7% for 2017. 

These predictions are based on backward looking figures from the City. Specifically, they’re based on the overly depressed interest rates of the past few months. 

During the past few weeks, there’s been a massive reversal in market interest rates, which banks use to offer funding to customers. This is good news for Lloyds, as the bank can increase lending rates charged to borrowers without having to worry about competitors taking business. 

Mortgage rates across the industry are already starting to see increases. Nationwide has increased the rates on some of its 10-year fixed mortgages by 0.3%. Skipton Building Society increased rates on some mortgages by 0.37%, while West Bromwich scrapped its market-leading 10-year fix and Virgin Money has increased the cost of borrowing across its mortgage range. As the UK’s largest mortgage lender, Lloyds is set to see more benefits than most from rising lending rates and, over the next few months, City analysts may start to raise their earnings expectations for the bank. 

Shares in Lloyds are already trading at an overly depressed valuation of only 8.2 times forward earnings. In comparison, shares in peer Barclays are trading at a forward P/E of 17.1 and shares in HSBC are trading at 13.5 times forward earnings. So Lloyds appears to be the runt of the group and, for this reason, I believe it won’t take much for the bank’s shares to quickly return to a higher valuation as the market regains trust in the company and its prospects. 

The bottom line 

Overall, Lloyds has fallen out of favour with the market during the past few months as analysts lower their expectations for the bank’s earnings. However, with interest rates now on the up, the lender’s outlook is improving. What’s more, shares in Lloyds trade at an overly depressed valuation. 

A combination of Lloyds’ improving outlook plus its depressed valuation should send the shares higher in the near-term. A rally above 60p and back up to post-Brexit highs seems likely. 

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.