From what I’ve been reading, the UK could benefit from four interest cuts next year from the Bank of England monetary policy committee. Lower interest rates should help to fuel economic growth, as consumers have more of an incentive to spend rather than save.
However, it might not be good news for Lloyds Banking Group (LSE:LLOY). Here’s what could happen to the Lloyds share price next year.
Why the impact is negative
It’s true that during a rate cut cycle, the stock market tends to do well. Yet this isn’t true for all sectors. For major banks, low interest rates are actually a bad thing. The key way for a normal bank to make money is to pay interest on deposits and lend it out at a higher loan rate. The difference between what’s paid on the deposit and what’s charged on the loan is called the net interest margin.
The Q3 net interest margin for Lloyds was 2.95%. This is with the base rate currently at 4.75%. Now let’s imagine (in theory) that the interest rate fell to 2% tomorrow. All of a sudden, the net interest margin for Lloyds becomes much smaller (probably around 1%).
Of course, interest rate cuts will be in gradual 0.25% increments next year. The impact on income will be the same. But fundamentally, I’d expect the net interest margin this time next year to be lower than where it is now.
Lloyds generated total net income of £12.7bn in Q3. Of this, £9.6bn came from net interest income. So clearly there will be a negative earnings impact of lower interest margins. In turn, this could cause the share price to fall, as investors factor in lower earnings.
Discussing details
The financial impact on Lloyds isn’t always immediate. It can take time for fixed rate loans to expire, with some customers also having fixed deposit rate deals. So changes to the net interest margin can take several quarters to filter through.
Further, the bank’s able to forecast the future net interest margin to some extent. For example, for Q4, the bank expect the margin to be above 2.9%. I’d expect the annual results released early next year to detail the forecast for the net interest margin for 2025. This will allow investors to decide whether the size of the negative impact is enough to make them want to sell or buy the stock.
Finally, investors aren’t stupid. Most will be aware of the hit from a reduction in rates next year. So some of the impact’s already factored in to the current share price.
Offsetting factors
Given that the stock’s up 20% over the past year, the concern around rate cuts isn’t a disaster (so far) for Lloyds.
One reason for this is that a lower base rate will stimulate economic activity. This could be in the form of higher transactions, more demand for mortgages and other products. Revenue from all of this will increase for the bank. This should help to offset some of the fall in revenue.
Ultimately, I believe growth in Lloyds shares will be stunted next year due to monetary policy actions. I won’t be investing right now. But it’s true that the exact size of the impact could be low enough to be tolerated by existing shareholders.
The post 4 rate cuts in 2025? Here’s the potential impact on the Lloyds share price appeared first on The Motley Fool UK.
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Jon Smith has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
