Will an interest rate hike bail out Lloyds Banking Group plc?

Investors in Lloyds Banking Group (LSE: LLOY) have enjoyed some respite over the past six months, with the share price climbing almost 25% in that time, to 65.5p. However, that still leaves the stock below its 52-week high of 74p. What will it take to get this bank moving again?

Brexit blowback

The EU referendum was a blow, as markets assumed the subsequent slowdown in the UK economy would hit Lloyds particularly hard, given its UK domestic focus. However, Brexit still hasn’t delivered the expected killer blow, with GDP up 0.6% in the final quarter of last year. Suspicions are likely to remain, though, and we should expect further turbulence when Prime Minister Theresa May triggers Article 50, on what may be a ‘hard’ Brexit, in March.

Lloyds looks tempting valuation-wise, trading at just 7.7 times earnings. However, its price-to-book ratio stands at exactly 1, which suggests it isn’t particularly undervalued, at least compared to Barclays at 0.6 and beleaguered Royal Bank of Scotland at 0.5. Lloyd’s dismal forecast earnings per share outlook is another worry, with analysts anticipating three successive years of declines, starting with -17% in 2016, followed by -4% this year and -7% in 2018.

Income hero

Clearly, investing in Lloyds is far from a one-way bet. At least the dividend seems to be heading in the right direction. Today’s 3.4% yield is covered a handsome 3.8 times, giving plenty of scope for progression, as the bank aims to pay out 50% of its sustainable earnings to shareholders. By the end of 2018, investors could be pocketing a juicy yield of 6.1%, which is where the true investment case for Lloyds now lies.

One shadow that’s been hanging over Lloyds is now fading, with news today that the UK government is cutting its stake to just under 5%, as it looks to take the bank entirely private in the next few months. However, UK consumer confidence is fragile, falling in January, as fears of a ‘hard’ Brexit mounted, according to today’s data from the European Commission.

Margin call

Director Jennifer Tippen has been charged with helping Lloyds prepare a three-year business plan to protect the lender from record-low interest rates, which are putting pressure on net lending margins. This is a concern for all the banks: interest rate hikes would allow them to quietly increase the margins on their mortgage lending and savings rates. Will they get what they want?

Analysts have been forecasting an interest rate hike for years, typically giving the vague prognosis of “within the next 18 months”. Like tomorrow, the next 18 months never actually comes. This year could be different, with CPI hitting jumping to 1.6% in December and further leaps expected due to the weaker pound, and some forecasters suggesting January’s number could exceed the Bank of England’s 2% remit, then top 3% by year end.

I still think the Bank’s monetary policy committee will be slow to act given Brexit uncertainties. That could leave Lloyds facing Brexit uncertainty and consumer anxiety, without the cushion of higher interest rates. However, these negatives would not deter me from buying into the bank today. Today’s 65.5p entry price is right. The yield curve is exciting. If you can afford to hold for the long term, I believe you should make money from this stock.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.