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Bank stocks tend to do better when interest rates are high. This is why Lloyds (LSE:LLOY) investors were certainly disappointed to see their shares end the year down 8%. However, I believe the following three catalysts could bring potential upside to the stock in 2023.
1. Better-than-expected economic data
Government and economic organizations are all predicting that the UK will go into recession this year. However, Lloyds’ Q3 report suggests otherwise. Management notes a base case scenario of how the UK economy will perform in 2023. In addition, an upside scenario is also laid out. If the majority of these metrics can be met, Lloyds shares could benefit.
| Metric | Base case | Case up |
|---|---|---|
| GDP | 3.4% | 3.6% |
| The unemployment rate | 3.7% | 3.3% |
| house price growth | 5.0% | 6.1% |
| Commercial real estate price growth | 2.8% | 8.7% |
| Bank rates | 2.06% | 2.16% |
| CPI inflation rate | 9.1% | 9.0% |
2. Net interest margin widens
The Black Horse bank earns most of its income from net interest income (NII). This means that Lloyds’ share price is more sensitive than other banks to interest rates.
With around £80bn of assets held in central bank reserves, it gets extra income for every rise in bank rates. As the Bank of England (BoE) may still increase rates a little this year, Lloyds is expected to see more NII margins. If the BoE does not drop bank rates below 2% by the end of the year, Lloyds shares could see limited downside risk.
Moreover, the bank’s balance sheet is in a healthy position to comfortably cover the increase in bad debts. This is due to the excellent CET1 ratio of 15%, which exceeds the minimum requirement of 4.5%. It is the amount of liquid assets to cover risky liabilities.
3. House prices are not falling
Having said that, the company will also pay attention to the housing market. As the country’s biggest mortgage lender, the housing market crash could see Lloyds’ earnings plummet, as well as its share price. After all, alarm bells have started ringing as the latest market data has started to show weakness.
However, smaller ‘corrections’ seem easier. Most banks and building societies don’t think average house prices will fall by more than 15% this year, which is in line with Office for Budget Responsibility estimates. In the event that the housing market remains stronger than expected, I can see Lloyds shares benefiting as mortgage affordability holds up to sky-high housing prices.
That said, I’m not bullish as a board for next year. The company’s share price is very closely related to the UK economy with little or no diversification in its income streams, and that’s really not exciting for me. Lloyds could benefit greatly in the short term, but the long term outlook remains ambiguous. So, I don’t see myself becoming an investor in the short term.
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