The Lloyds Banking Group (LSE:LLOY) share price has been struggling in 2023. But the stock has started to rally after hopes of an interest rate reduction in 2024.
It’s worth emphasising that the Bank of England hasn’t announced a cut yet, and I don’t think Lloyds is the bank that has the most to gain from lower interest rates. But I do think the share price would move higher.
Interest rates
One reason for this isn’t specific to Lloyds, or even the banking sector — lower interest rates are good for share prices in general. This is because investors can’t get such a good return on cash and bonds.
As a result, anyone looking for a decent return has to consider riskier assets, such as stocks. This is most commonly the case with pension funds that have a specific annual return to aim for.
If a pension fund can’t get its required return from less risky assets, it has to go hunting elsewhere. This causes demand in the stock market to rise, pushing asset prices higher.
That doesn’t have anything to do with Lloyds specifically. But if the Bank of England cuts interest rates in 2024, the stock could go higher as part of a more general market rally.
Bad loans
Another reason is much more specific to the banking sector. The biggest headwind facing UK banks in 2023 has been the issue of bad debts.
As a result of higher rates, customers have found themselves paying more interest on loans such as mortgages. This has made them unaffordable in some cases and caused a number of debts to go bad.
In the first half of the year alone, Lloyds recorded £662m in charges for bad debts. That’s a lot for a company that pulled in around £2.6bn in net income during that period.
Margins
An interest rate cut would likely come at a cost, though. As rates have increased, the bank has been able to improve its net interest margins — the difference between the interest it pays out and the interest it collects.
This is a key measure of banking profitability, especially in the case of Lloyds, which has no investment banking division and the largest share of UK deposits. I suspect this might contract again if rates get cut.
Investors should therefore keep an eye on the company’s earnings. Even if the share price does go up, the value proposition is one to watch closely.
Should I buy Lloyds shares?
Lloyds may have recorded higher charges for bad debts over the last couple of years, but it’s no coincidence that net income has also been higher. As a result, I’d be wary of the rise in interest rates.
Right now, the stock might be moving higher in anticipation of an interest rate cut. But that increases the risk, in my view — if the expected cut doesn’t materialise, the stock might well fall again.
I think the Lloyds share price still looks attractive at the moment. But I’m very much reserving the right to change my view on that one if the market’s optimism keeps going.
