Lloyds (LSE:LLOY) shares are well and truly on the back foot. Down 10% over the last five days, it’s been uncomfortable viewing for investors who’ve become used to the bank delivering stunning returns.
But should we really be surprised by the pullback? As I say, Lloyds’ share price has been on a tear for the last 12 months — it’s up 64%, smashing the broader FTSE 100, which has risen 4%. Some would argue a cooling off was inevitable as investors book profits following those spectacular gains.
That’s not all that could be dragging the bank lower. At 102.5p per share, Lloyds looks historically expensive (more on this later). This could be encouraging shareholders to cash out, and especially given the uncertain outlook for 2026 and beyond.
However, is there something else going on under the surface that’s pulling the bank lower? And what might Lloyds shares do next?
Cutting crew
It’s no coincidence that Lloyds shares began falling when the Bank of England (BoE) met for its latest interest rate decision. It wasn’t what policy makers did that spooked investors — they elected to keep their lending benchmark locked at 3.75%, as expected.
Rather, it was the closeness of the vote that caught the market by surprise. Four of the five ratesetters wanted to cut the rate, more than had been expected. So why did this have such an impact on UK-focused retail banks?
Thee are two key reasons: firstly, it suggested policy makers are more worried about the state of the British economy than had been expected, reinforcing their appetite to cut rates. Lloyds’ sources almost all its profits from here, so weak UK growth is a severe threat to earnings.
Secondly, the narrow five-to-four decision makes it far more likely of an interest rate cut at March’s next meeting. Though reductions can boost banks’ top lines, they can be a net negative by pulling their net interest margins (NIMs) to wafer-thin levels.
Lloyds’ NIMs have remained resilient so far. They actually rose 11 basis points in 2026, to 3.06% But fears they could return to the mid-1% range of the 2010s are mounting, as inflationary pressures ease and the BoE slashes rates.
Can Lloyds shares recover?
The question is, can Lloyds’ share price rebound from current weakness? I wouldn’t bet the mortgage on it, though there are some causes for optimism. The housing market is slowly but steadily improving, which is a key profits driver for the bank. Investment in digital is also paying off by improving customer engagement and pulling down costs.
Yet on balance, I think there may be more pain in store for Lloyds shares. It’s not just the prospect of more interest rate cuts and prolonged weakness in the UK economy that might turn investors off. Rising competition from challenger banks, high costs, and regulatory challenges all pose big problems for the bank in 2026 and beyond.
And as I said at the top, Lloyds shares still looks mightily expensive. The bank’s price-to-book (P/B) ratio is 1.5, well above the 10-year average of 0.9. If trading does indeed deteriorate, and investor confidence continues to wane, a high valuation could magnify the scale of any price decline. This could attract dip buyers, but I’m happy to avoid the bank right now.
