High interest rates are a good thing for retail banks like Lloyds Banking Group (LSE: LLOY). The higher the benchmark, the larger the margin between what banks can offer to savers and to lenders. This can have a huge impact on bank profits.
The Bank of England kept its core rate locked around record lows in the 10-plus years following the financial crisis. Profits at the likes of Lloyds suffered as a result and the share prices of these financial leviathans dragged. The Lloyds share price actually rose a disappointing 12% between 2010 and 2020. Compare that to the roughly 40% rise the broader FTSE 100 recorded.
The Lloyds share price rises on rate expectations
Could things finally be about to turn conclusively for the Lloyds share price, though? Over the past year, the bank has risen 53% as expectations of sustained interest rate rises have grown. In December, the Bank of England hiked its benchmark for the first time since autumn 2017, from all-time lows of 0.25%. The smart money is on another increase at the next meeting on Thursday, 3 February too.
Market commentators predicted rate rises because of the UK’s strong economic rebound from Covid-hit 2020. Supercharged inflation gauges more recently have amplified the pressure on the central bank to act, too (consumer price inflation just hit 30-year highs of 5.4%).
Will inflation keep soaring?
Even if the Bank of England acts this month, though, it’s possible that the inflationary pressure will continue to grow. Energy prices are soaring and the issue could get worse if Russia invades Ukraine. The impact of post-Brexit trade regulations on existing supply chain problems could also send prices higher.
Finally, a rise in the UK national living wage to £9.50 from April threatens to fuel inflation further still. Chairman of the Treasury Committee and Conservative MP Mel Stride recently commented that “focusing on increasing wages without improving productivity is likely to be inflationary, and risks contributing to a wage-price spiral”.
Why I’d buy other FTSE 100 shares
It’d be a stretch to imagine that the Bank of England, to the benefit of Lloyds and the other banks, will continue raising rates to match the inflationary surge, however. At some point policy makers will have to halt hiking the benchmark so as not to choke off the (already flagging) economic recovery.
It’s my opinion that the risks to the economic rebound are rising. This is reflected in economists cutting their GDP growth predictions for 2022. And it’s the main reason why I’m not tempted to invest in highly-cyclical shares like Lloyds. Corporate insolvency rates are already rising sharply, and the pressure on individual and household budgets looks set to rise further once larger National Insurance contributions come into effect in the spring.
City analysts think Lloyds’ annual earnings will drop 23% in 2022. I think the chances of a more painful decline are growing, however, as are the prospects of bad loans surging and sustained pressure on revenues. And I worry that these problems could drag beyond the current year too. I’d rather buy other FTSE 100 shares today.