It was all going so well for Lloyds‘ (LSE:LLOY) shares. The FTSE 100 bank had risen 80% in 2025, and got the current calendar year off to a flyer. Now it’s slumped 12% in just three weeks, putting it firmly in correction territory.
So what’s going on at the Black Horse Bank? And can the Lloyds share price stage a stunning recovery?
Rate expectations
It’s important to stress Lloyds isn’t the only major bank that’s sinking right now. The entire sector’s in the red, as investors consider the impact of the Middle East war on earnings.
Disruption to oil supplies and attacks on oil & gas fields are sending energy prices skywards. The subsequent inflationary pressure this creates mean interest rates cuts are firmly off the table, and with them support for economic growth that might boost loan demand.
Last week, the Bank of England (BoE) kept its lending benchmark on hold at 3.75% when a cut had previously been widely tipped. Not only that, but policymakers warned that “we [will] assess how events unfold… whatever happens, our job is to make sure inflation gets back to its 2% target“.
Traders and analysts now expect interest rates to rise twice in 2026. Speculation of more aggressive increases will surely rise the longer the war drags on.
Threats to Lloyds’ shares
So why are Lloyds shares in free fall? We hear constantly that higher interest rates are good for banks’ net interest margins (NIMs), after all. Lloyds’ own margin rose from 2.54% to 3.06% during the four years to the end of 2025, reflecting higher BoE rates.
The problem is greater interest rates can also choke off revenue growth and drive up impairments. In the case of retail banks, this can significantly outweigh the boost they give to NIMs. Lloyds booked an enormous £1.5bn worth of bad debts in 2022 when rates last trended steadily higher.
I’m not saying interest rates will rise as strongly as they did back then (they rose more than 3% in 2022). But the impact could still be a painful and potentially a protracted one if the Middle East conflict escalates.
Potential to plunge
An extra problem for Lloyds is that higher interest rates can be especially crippling for the homes market. The FTSE 100 bank is by far the largest mortgage provider in the UK. If buyer affordability crumbles and home sales cool, the firm loses a key profit driver.
So how low could Lloyds’ share price go? It’s hard to say as the conflict between the US, Israel and Iran rolls on. The thing is, that’s not the only danger facing the banking giant — growing competition and rising motor finance misconduct charges are other major earnings threats at the start of 2026.
On balance, there’s good reason in my view to expect Lloyds’ shares to keep tumbling. And especially given that the bank still carries a chunky price-to-book (P/B) ratio of 1.4, well above historical norms.
