How will the Lloyds share price react to uncertain economic outlook?

Lloyds Banking Group’s share price has had a bumpy ride so far in 2022, but the shares are still ahead over the past six and 12 months, despite slipping back this year.

After the Covid-19 pandemic caused Lloyds and many other stocks to plummet – Lloyds’ [LLOY] share price sunk to an eight-year low in September 2020 – the UK’s biggest bank is now faced with other macroeconomic issues to contend with, such as the threat of a fast-rising inflation rate and climbing interest rates. And, as the UK’s largest mortgage lender, it’s likely more sharply attuned than most to the health of the country’s economy.

Prospective investors are faced with weighing up whether Lloyds’ relatively low valuation offers an opportunity to pick up a solid long-term growth option at an attractive price, against the threat of an inflation environment that could hurt the bank’s prospects. 

What’s happening with the Lloyds share price?

Lloyds’ share price is down 0.86% so far in 2022, after closing last Friday at 47.39p, but the shares are 6.29% higher over the previous six months, and 11.18% up year-on-year.

Looking slightly further back, Lloyds shares have jumped 91.71% since plunging to just 24.72p in September 2020, but still remain below pre-pandemic peaks above 60p.

How will Lloyds’ share price react to soaring inflation and rate rises?

At the start of last year, and with the latest lockdown in force, Lloyds referred to an uncertain outlook, warning that many of its customers might find themselves in financial difficulty, and the current sharply rising cost of living has brought this scenario sharply back into focus.

On 23 March, the Bank of England confirmed that the UK’s inflation rate had leapt to a 30-year high of 6.2% in February, up from 5.5% in January. CMC Markets’ Michael Hewson said “the odds of a double figure print for headline CPI [inflation] appear to be becoming increasingly likely.”

This jump in inflation has led to the Bank of England lifting the UK base rate from all-time lows up to 0.75%, where it stood before the pandemic hit. Higher interest rates are generally positive for banks, and this applies especially in Lloyds’ case, with its focus on mortgages and other forms of lending. Lloyds will, like all lenders, increase its lending rates, which should help to boost revenue.

There’s a more downbeat side to the argument, however. Although there is not yet any evidence for its effect on the housing market, the soaring cost of living and the resulting squeeze on households’ disposable incomes may reduce the demand for mortgages and other loans. This could lead to a slowdown in the housing market, hitting the bank’s interest income.

Hargreaves sums up the worst-case scenario, suggesting that “if the economic situation deteriorates significantly, as one of the largest financial institutions in the UK, Lloyds will almost certainly suffer”.

Lloyds’ potential boosted by low valuation

“These potential headwinds are the main reasons why the market is placing such a low multiple on the stock”, according to Hargreaves. It’s therefore extremely difficult to forecast when Lloyds’ share price might trade at a higher valuation. At 6.38 as of 1 April, Lloyds has a comfortably low price-to-earnings ratio.

The stock’s price-to-book (P/B) value of 0.7 offers further evidence to support the low valuation argument, according to Hargreaves, who says “any company that is sustainably profitable should be selling at a P/B value of 1 or more”. Based on the 42.8% disparity in its P/B value, this suggests that the stock is undervalued.

It’s no surprise, then, when Hargreaves says the bank’s shares “looks cheap compared to its potential when analysing the company’s underlying fundamentals and growth outlook … over the next five to 10 years, the Lloyds share price will begin to reflect the company’s underlying fundamentals.” Investors may have to be patient, although in the meantime, the resumption of dividend payouts is reassuring.

What’s next for Lloyds’ share price?

There’s little doubt that Lloyds, like other banks, faces a period of heightened uncertainty. But for investors, the bank appears to be emerging from a prolonged spell in the doldrums, while a low valuation, and the reintroduction of dividends, could make the bank a potential target for some.

The overall picture from analysts following the stock is generally upbeat. Lloyds’s share price outlook shows three ‘buy’, 13 ‘outperform’, six ‘hold’ and two ‘underperform’ according to the FT. Offering further hope for the bank’s prospects, the 19 analysts offering 12-month price targets have a median target of 60.00p, with a high estimate of 88.00p and a low estimate of 44.00p. The median estimate represents a potential upside of 26.61% compared with last week’s close at 47.39p.