Should I buy Lloyds shares for passive income?

Is Lloyds a great stock to buy to boost my dividend income? Here are the pros and cons of investing in the FTSE 100 bank.

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The Lloyds Banking Group (LSE: LLOY) share price is taking a battering. A stream of poor economic data and downwardly-revised UK growth forecasts are smacking appetite for the banking share.

The outlook for Lloyds in 2022 — and 2023, if OECD forecasts of no growth are to be believed — is quite grim. But, as a long-term investor, should I be looking to exploit recent weakness by buying the bank on the cheap?

Lloyds’ sinking share price has driven its dividend yield through the roof. And as someone who invests for passive income I’ve sat up and taken notice. The bank’s yield now sits at 5.5%, way above the FTSE 100 average of 3.9%.

Rising rates to boost Lloyds

What’s more, recent share price weakness means the Footsie bank now trades on a price-to-earnings (P/E) ratio of 6.8 times. Lloyds fans would argue that this makes it too cheap to miss. And particularly so as interest rates rapidly rise, boosting the margins it makes on its lending activities.

Claudia Nelson, senior director of banks at Fitch Ratings, notes: “Major UK banks [will] benefit most from rising interest rates given their large market share in current account deposits.” And Lloyds is one of these big players that stand to gain enormously.

The Bank of England (BoE) has upped interest rates for five consecutive months in response to curb soaring inflation. Calls for more aggressive action are growing as well. This week, key policymaker Catherine Mann called for “a more robust policy move” as the falling pound worsens the scale of price rises.

Mann isn’t the only one calling for more aggressive interest rate hikes either. It’s why analysts at ING Bank think rates — which currently sit at 13-year highs of 1.25% — will rise an extra half a percentage point in August.

Mortgage arrears soar

Having said that, the risks to Lloyds’ profits and its share price are colossal despite the benefit of rising interest rates.

The UK economy is sinking as inflationary pressures spectacularly grow. Worryingly, the BoE again cut its growth forecasts and now thinks GDP will shrink 0.3% in Q2.

As a potential investor I worry about sagging bank revenues and an explosion of bad loans as Britain toils. I’m particularly concerned for Lloyds, given its position as the country’s largest mortgage lender. Home loan arrears have recently spiked to their highest in 12 years.

A dangerous pick for passive income?

Lloyds’ cheap share price reflects these growing near-term threats. It also reflects its uncertain future once the cost of living crisis eventually passes. The rising popularity of challenger banks is another threat to established operators like this. So is the long-term economic impact of Brexit on the UK economy and, consequently, on bank income.

That 5%+ dividend yield that it offers certainly looks appetising right now. But I’m not tempted to buy into the business today. The key to enjoying a steady passive income is to own shares that can pay decent dividends over the long haul. I’m not sure Lloyds will have the financial firepower to do this as the decade progresses.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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