The storm clouds gathering over the UK economy continue to worsen. It’s a situation I can’t afford to ignore while choosing cyclical FTSE 100 shares like Lloyds Banking Group (LSE: LLOY) to buy.
As things stand, runaway inflation is the biggest threat to the global and domestic economies. In Britain, this hit new 30-year highs of 6.2% in March. It’s tipped by the Treasury to eventually peak at 9% in 2022.
Interest rates to soar
For Lloyds and its share price these rampant price rises pose a threat as well as an opportunity. Demand for credit and loans is rising as people try to ride out the storm with increased borrowing.
The biggest benefit for the banks though is that central banks are hiking rates to curb the inflationary bubble. Lloyds benefits in this scenario as it boosts the profits it makes with its lending activities.
The Bank of England (BoE) in March raised its benchmark rate to pre-coronavirus highs of 0.75%. And economists are expecting a flurry of further hikes as the cost of living crisis bites.
Analysts at JP Morgan, for example, expect the BoE to increase rates a further four times this year. They expect the benchmark to end 2022 at 14-year peaks of 1.75%.
The risks to Lloyds
Things are looking up for Lloyds on the one hand. But on the other, the risks facing this economically-sensitive FTSE 100 share are also rising.
For one, it remains to be seen what impact rate rises will have on headline levels of inflation. The pressure on consumers and businesses could remain significant for longer, putting immense pressure on Lloyds’ earnings.
I fear that a raft of bad loans could be coming down the pipe for Britain’s banks. And it’s not just rocketing inflation that could hit Lloyds’ operations hard.
A raft of tax rises coming into effect today — chief among them National Insurance rises — threatens to add further strain on the struggling economy.
One final thing. Further BoE rate rises could actually also hit Lloyds hard if it freezes the housing market. The FTSE 100 bank is by far Britain’s biggest mortgage provider with a one-fifth share of the market.
Lloyds’ share price is cheap!
Of course all UK stocks face dangers like Lloyds. There’s no such thing as a dead cert when it comes to share investing.
And I think a case could be made that Lloyds’ cheap share price could reflect the dangers it faces. Today, the bank trades around 46p per share. This leaves it dealing on a forward P/E ratio of 7.7 times.
This is well below the widely-regarded benchmark of 10 times and below. But despite this I’m still not buying. There are plenty of other dirt-cheap Footsie shares for me to choose from today. Stocks that have a much brighter profits outlook than Lloyds.
As well as the threats above, I also worry about Lloyds’ ability to generate decent earnings growth, given its lack of overseas operations and the increasing threat posed by challenger banks.