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Is Lloyds Banking Group plc an inspired — or insane — stock pick?

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It isn’t difficult to see why market appetite for Lloyds Banking Group (LSE: LLOY) has fallen through the floor in 2016.

The share price was already in deficit at the time of June’s referendum, with investors digesting the prospect of prolonged low interest rates in the UK. But the Brexit decision has really put the boot into Lloyds’ share value, the bank now dealing at a 28% discount to levels recorded at the start of the year.

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The Bank of England has of course responded by slashing rates to fresh record lows. However, a recent uptick in data has suggested that the British economy may not be about to tip off a cliff, as some had widely predicted.

This has reduced speculation that another rate cut could be in the offing. Indeed, Monetary Policy Committee member Kristin Forbes played down the likelihood of another reduction in recent weeks by commenting that “the economy is experiencing some chop, but no tsunami.”

Forbes did add, however, that “the adverse winds could quickly pick up… and merit a stronger policy response.” Economic data has been extremely volatile since the vote, with gauges on the housing market, high street activity and business confidence all far from reassuring.

And the bad news has kept on coming for Lloyds. As if dealing with a potential cooldown in the British economy wasn’t enough to contend with, the Financial Conduct Authority added to Lloyds’ woes in August by stretching out a proposed PPI claims deadline to 2019, extending its prior suggestion of a 2018 cut-off.

All priced-in?

Still, many would argue that Lloyds’ troubles are more than baked-in at current prices. Indeed, predicted earnings declines of 14% and 13% in 2016 and 2017 respectively result in P/E ratings of 7.2 times and 8.3 times. These readings are far below the benchmark of 10 times one would expect of high-risk stocks.

And the City expects Lloyds to smash many of its rivals in the dividend stakes too. Payments of 3.1p and 3.5p per share are predicted for 2016 and 2017, yielding 5.8% and 6.6%. By comparison the FTSE 100 average stands closer to 3.5%.

No upturn in sight

However, the prospect of prolonged difficulties in the UK economy could bury the chances of any bottom-line turnaround at Lloyds, making investment in the bank still hard to justify regardless of these ultra-cheap multiples.

Besides, the jury remains very much out on whether Lloyds will be able to meet current dividend forecasts. Not only could sickly income growth and a further rise in PPI bills put paid to any hefty dividend lift, but the Bank of England’s guidance that British banks don’t lift dividends following July’s liquidity injection into the sector could prove another significant obstacle for dividend chasers.

I reckon the problems over at Lloyds are far too significant at the present time, and think the bank could be in for a long, hard slog in the years ahead.

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

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