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What could higher inflation mean for Lloyds shares?

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Lloyds (LSE:LLOY) shares pushed upwards on Wednesday as UK inflation came in higher than expected. Inflation — based on the Consumer Prices Index (CPI) — was reported by the Office for National Statistics (ONS) at 10.1%, with around half of that down to soaring energy prices.

So, what does this mean for Lloyds?

Recent performance

In late July, Lloyds Bank lifted its annual guidance after a rise in net income for the half-year due to rising interest rates, and despite a fall in H1 pre-tax profits.

Net income jumped 12% versus the previous year, to sit at a healthy £8.5bn. However, pre-tax profits fell 6% to £3.6bn. This fall in pre-tax profit was largely due to the previous year’s earnings being boosted by the release of cash set aside to cover expected Covid-related defaults.

The bank has been benefiting from higher rates. Lloyds said its net interest margin, the difference between savings and lending rates, was now expected to be greater than 280 basis points.

The share price has pushed upwards since the H1 report was published.

Outlook

Today’s higher inflation data will put pressure on the Bank of England to raise interest rates further to slow spending and lower inflation, bringing it back towards the 2% target.

Further interest rate rises should have a positive impact for Lloyds, expanding its net interest margin even more. UK mortgages represented 61% of the bank’s total gross lending at 2021 year-end. And two-thirds of the Lloyds’ income comes from the UK. 

Higher rates will have a sizeable impact on average mortgage repayments in the UK. While the rate rises may seem negligible, the increase for every rate rise is substantial for both customers and the bank.

However, it’s likely that higher interest rates will also lessen demand for new mortgages. And this may negatively impact the business going forward. That said, new mortgages should just be deferred until consumer sentiment improves.

Recession forecasts also won’t be good for the bank and it has already has put money aside for defaults this year.

Beyond the near term, I like the bank’s move into the housing rental market. Lloyds is reportedly buying 50,000 homes in the UK over the next decade with the intention of letting them out.

Would I buy Lloyds stock?

I’m pretty bullish on Lloyds and I contend that the share price has plenty of headroom for growth. It’s also pretty cheap and currently trades with a price-to-earnings ratio of just 6.1. This is more expensive than Barclays, but cheaper than other peers, some of which are more diversified.

Despite the recession forecasts, I think the near-term forecasts for the bank are actually very positive. After all, base rates are rising from being near zero for the first time in a decade.

At today’s price, I’d buy more Lloyds shares for my portfolio.

The post What could higher inflation mean for Lloyds shares? appeared first on The Motley Fool UK.

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James Fox owns shares in Barclays and Lloyds. The Motley Fool UK has recommended Barclays and Lloyds Banking Group. 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.