Over the past week, the risk of a no-deal Brexit has risen substantially. Or has it? Last Sunday was meant to be the deadline for talks, but this has been pushed back again. At the same time, PM Boris Johnson has commented that it’s very likely the UK will leave the EU and move to WTO terms from January. It’s hard to tell where political games end and reality starts, but investors need to be prepared either way. As Lloyds Banking Group (LSE: LLOY) is one of the most traded stocks in the FTSE 100, the share price could be volatile whatever the outcome.
A negative outcome for Lloyds shares
Simply put, I think that a no-deal Brexit would almost certainly see the Lloyds share price slump in the short term. This is because of the perceived impact investors think a no-deal would have on the bank. In the immediate aftermath, we won’t know for sure what the impact will be. But this won’t stop the share price from reacting to the worst-case scenario.
For example, a no-deal could see international trade dry up, with imports becoming more expensive and exports getting smaller. This would give the UK a wide trade deficit, leading to slower economic growth (or even negative growth). The Lloyds share price is seen as a barometer for the UK economy, and so could fall on the above thinking.
UK-focused companies like Lloyds would also miss out on any benefit from a weaker British Pound. A no-deal Brexit could see the pound fall up to 10%. This would help net exporters within the FTSE 100, as foreign earnings buy more pounds. For Lloyds and other businesses that operate mostly in the local currency, there’ll be no benefit here.
Company-specific issues
A no-deal Brexit could hamper the Lloyds share price at a company-specific level too. In order to soften the shock to the economy, the Bank of England would likely cut interest rates down to 0% or even negative. The margin that Lloyds makes between what it lends at, versus what borrows at, would be reduced even further. We’ve already seen rate cuts this year hurt the profitability for the bank.
Add to this the potential bad debt provisions needed to be set aside. In the second quarter of 2020, Lloyds set aside around £2.4bn in provisions due to the pandemic. I’m confident no-deal wouldn’t hurt businesses as hard as the pandemic has done, but the bank would still need to set aside an extra provision to cover this event, which is negative for the bank overall.
One of the few positives that can be taken away for the Lloyds share price is that it’s already starting from a low price. The shares trade around 35p at the moment, down almost 50% from a year ago. The last time it traded this low for a long period was back in 2012. So a no-deal event could knock it down, but how much lower can it really go?
Overall, I think a no-deal Brexit is bad news for the Lloyds share price. I’m staying away from investing in it until we have more clarity on the situation.
