There aren’t many risers on the FTSE 100 in midweek trading. But Lloyds Banking Group (LSE:LLOY) shares — along with those of other high-street banks Barclays and NatWest — have all risen in value.
These shares have benefitted from news that inflation in the UK remains stubbornly high. As prices continue to soar, speculation has risen that the Bank of England (BoE) will hike interest rates further and keep them elevated for longer.
So is now the time for investors to buy Lloyds shares?
Inflation shock
To briefly recap, higher interest rates boost the profits banks make from their lending activities. This is because they widen the difference between the interest these companies charge borrowers and what they offer to savers.
The BoE had been tipped to raise rates from 4% to 4.25% in May before then quitting the tightening cycle as inflation declines. The market was even pricing in a slew of interest rate reductions from the second half of 2023.
But fresh inflation data on Wednesday seems to have changed expectations. Consumer price inflation (CPI) in March remained stubbornly high at 10.1% when a fall to 9.8% had been tipped.
The UK remains the only major European economy where inflation remains in double digits. And CPI is running around double the level currently experienced in the US.
So what now?
March’s readout is no anomaly, either. The month before, inflation actually rose to 10.4% when it had been tipped to fall. And worryingly food price inflation continues to rocket, hitting new 45-year highs in March.
This means that, to the benefit of Lloyds and its peers, the BoE may raise rates further than the market expected. Following this morning’s CPI reading, the City is now braced for interest rates to peak at 5%.
Sure, inflation is coming down. But given the overall picture, rate expectations could continue trending higher.
Why I’d avoid Lloyds shares
The importance of high rates to Lloyds and its share price can’t be overstated. Even as loan impairments rose last year, the bank’s net income increased 14% to £18bn as the BoE kept hiking its benchmark.
Yet despite today’s news, I’m still not tempted to buy Lloyds shares. This is because the multiple dangers to its profits still offsets the benefit brought by higher rates.
I’m mostly concerned that the number of bad loans could keep surging as the UK economy struggles. And it threatens to wipe out profits in the short to medium term. This was the case in 2022 when pre-tax profits flatlined around £6.9bn as loan impairments leapt above £1.5bn.
In this scenario, the bank might also struggle to grow revenues as demand from consumers and businesses dries up.
Lloyds also faces a significant and growing threat from digital-led banks. And it is having to spend a fortune in areas like IT to better compete with the likes of Revolut and Monzo, putting a further strain on earnings.
The Lloyds share price trades on a forward price-to-earnings (P/E) ratio of 6.5 times. But I believe this low valuation reflects the huge dangers to the bank’s profitability. I think investors would be better off buying other cheap shares today.
