Should investors maintain interest in the Lloyds share price?

The Lloyds [LLOY.L] share price fell 6% last week, the UK banking giant’s shares continuing to struggle this year. On the flip side, the recent drop off in the firm’s first-quarter pre-tax profit still surpassed analysts’ expectations, while last week’s latest Bank of England rate hike could give Lloyds’ prospects a lift.

There are plenty of risks in the current uncertain economic environment, however, and the UK government’s move last year to give banks more power to offer mortgages to customers could backfire, as the likelihood of defaults rises in the face of the cost of living squeeze.

So, is the outlook for Lloyds becoming brighter, or is this FTSE 100 stock likely to be weighed down for the foreseeable future?

What’s happening with the Lloyds share price?

Lloyds’ shares are down 11.89% year-to-date, after sliding 5.92% last week to close at 43.37p. The share price is 6.85% lower year-over-year, but 13.83% above 7 March’s 52-week low of 38.10p.

On a two-year basis the Lloyds stock price is up 52.12%, after plunging to depths of around 28p during the early stages of the pandemic in May 2020.

Is the latest UK rate hike a positive for Lloyds?

In an effort to combat soaring inflation, the Bank of England’s monetary policy committee raised the UK base rate by 0.25% for a fourth consecutive time last week, pushing interest rates up to 1%, their highest level in 13 years. In fact, three of the nine MPC members voted for an even larger 50 basis point rise. These rate increases help to boost Lloyds’ net interest margin — essentially the difference between what it charges its customers through loans and mortgages, and the interest it pays out to customers with savings accounts.

In its Q1 update on 27 April, Lloyds said it was boosting its guidance on net interest rate margin to 2.7%. With further rate rises forecast through 2022, Lloyds’ margins are likely to reap the benefit. In fact, some commentators estimate UK rates could go as high as 2% this year. Ultimately, profitability is increased, and this should offer a boost for the stock.

Another leg up for Lloyds has come in the shape of the mortgage guarantee scheme, introduced by the government in April 2021 and due to run until the end of this year. It offers Lloyds and other mortgage lenders more scope to offer 95% loan-to-value mortgages, for people with a smaller deposit who would not normally be able to get one. With a government guarantee to back any mortgage defaults under the scheme, Lloyds is able to sell more mortgages, providing another fillip to the bottom line.

Will the soaring cost of living pull the reins on Lloyds?

Lloyds’ revenue potential is closely linked with the strength of the housing market. The bank represents around 19% of the UK mortgage market, according to the Motley Fool. The level of exposure that Lloyds has also comes with risks: with interest rates rising fast, mortgage holders with variable rate mortgages will see their monthly bills climb, and some customers are likely to run into arrears and ultimately default on their mortgages.

Indeed, Lloyds set aside an impairment charge of £177m in its Q1 update to cover likely customer loan defaults as some customers inevitably succumb to the cost of living squeeze. This may be repeated in Lloyds’ half-year results, which are due on 27 July. The upshot for Lloyds is that it’s likely to hit profits, particularly with UK inflation now at 7% and set to continue rising.

CEO Charlie Nunn recognised this threat in the recent update, saying: “Whilst we are seeing continued recovery from the coronavirus pandemic, the outlook for the UK economy remains uncertain, particularly with regards to the persistency and impact of higher inflation. We are proactively contacting customers where we feel they may need assistance and will continue to help with financial health checks and other means of support. We encourage customers, where affected, to get advice early and talk to us.”

What’s the outlook for Lloyds?

The future direction of Lloyds’ share price largely depends on whether the UK avoids a recession and house price crash. Housing shortages and still historically low mortgage rates means the outlook appears healthy. With a price-to-earnings ratio of 6.2, the stock is still trading at a relatively affordable level.

While the Motley Fool’s Finlay Blair suggests that “the share price is unlikely to dramatically soar in the coming year due to the uncertainty ahead in the economy and banking industry”, he says Lloyds’ 4.3% dividend is attractive for potential investors.

What are analysts forecasting for Lloyds’ stock?

The 19 analysts offering 12-month price targets for Lloyds have a median target of 60p, with a high estimate of 91p, and low estimate of 45p, with the Financial Times. The median estimate represents a 38.34% increase from Friday’s close at 43.37p.

With four ‘buy’, 12 ‘outperform’ and five ‘hold’ recommendations among analysts following the stock, along with three ‘underperform’ and no ‘sell’ ratings, 16 analysts are positive on Lloyds, compared with just three who hold a negative viewpoint. While there are potential tailwinds for Lloyds’ share price, the uncertain macroeconomic environment is likely to make things unpredictable for some time to come yet.