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Could Lloyds shares soar with interest rates still rising?

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In the summer, I was expecting Lloyds (LSE:LLOY) shares to push above 50p and stay there. But then we had an economic whirlwind in the form of Liz Truss and her disastrous economic policy that sent the market, and banks, tanking.

Like all banks, this FTSE 100 stalwart is facing headwinds, but there is also one major tailwind. So let’s take a closer look at Lloyds’ fortunes and see whether this blue-chip stock is right for my portfolio.

Headwinds

Let’s start with the headwinds. In late October, the bank said pre-tax profit for Q3 fell 26% to £1.5bn. Impairment charges soared to £668m from a release of £119m a year ago. This large debt provision is hopefully not going to be entirely necessary, but it does speak volumes about the perceived health of the UK economy.

There are recessionary forecasts for the UK economy, as with much of Europe. And recessions aren’t good for credit quality. However, it’s worth noting the UK economy has surprised us before. Plus falling gas and fuel prices could play an important role in slowing inflation.

Tailwinds

Interest rates have been increasing throughout 2022. It’s likely that the Bank of England will continue increasing the base rate through to 2023. In fact, some analysts see the base rate hitting 4% in 2023.

As such, net interest margins (NIMs) — the difference between savings and lending rates — are rising considerably. In its Q3 update, Lloyds said it expects its NIM to be above 2.9%, up from 2.8%. Lloyds is even earning more interest on the money it leaves with the central bank.

Lloyds trades at a fraction of its pre-2008 crash price. There are several reasons for this, but a major one is more than a decade of near-zero interest rates. Now, with rates increasing to levels not seen since the noughties, income is soaring. Despite the impairment charges, net income in Q3 rose 12% to £13bn on the back of surging interest rates.

This is clearly positive. It provides the bank with the ability to absorb sizeable impairment charges in the short term. But, in the long run, it should provide Lloyds with more capital to invest in new projects. For example, Lloyds is planning to enter the UK rental market by buying as many as 50,000 homes over the next decade. It’s definitely a project that interests me.

Why I’m buying more Lloyds stock

I already own Lloyds shares but, at 42p, I see now as a good time for me to buy more. Despite the immediate headwinds, I’m confident higher interest rates will translate into greater returns for shareholders in the medium-to-long term.

It’s certainly not expensive either, with a price-to-earning ratio of 5.6 — that’s substantially under the index average. And despite dividend payments being depressed on a historical basis, the yield is currently a healthy 4.75%. That’s certainly attractive and, with coverage at 3.75 last year, sustainable.

The post Could Lloyds shares soar with interest rates still rising? appeared first on The Motley Fool UK.

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James Fox has positions in Lloyds Banking Group. The Motley Fool UK has recommended 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.