Bank Watch: Why BoE hike warning hasn’t lifted bank shares

Bank stocks need more than the threat of higher rates to rise nowadays

The Bank of England wants us to believe that it could raise interest rates as soon as November. In theory, that ought to have aided shares in Britain’s banks, not least the largest retail lender, Lloyds Banking Group. Higher rates are the most important ingredient banks need to make more money from lending: net interest income. If borrowing costs are or perceived to be on the brink of turning a corner, a potential rise in bank profits ought to be reflected in their shares.

But FTSE 100 bank shares fell immediately after The Bank’s statement last Thursday and stayed down after its Governor, Mark Carney, reiterated in a television interview that the possibility of the BoE’s first rate rise in a decade had “definitely increased”.  On Monday, Lloyds shares remain most marked, trading down about 2% since Wednesday’s close. The path to any change in policy is unlikely to be easy to predict, even for the BoE, after all. And for banks, the link between share price performance and rates is no longer clear cut.

For one thing, potentially steepening inflation—primarily transmitted by sterling’s 4.8% trade-weighted jump since late August— is not an immediate benefit for domestic-focused banks like Lloyds. And even a single symbolic 25 basis point rise could hasten inflation in the medium term. Lloyds is also Britain’s biggest mortgage lender, so higher rates would have to be passed on to more of its borrowers than at its rivals. More widely, if rates rise and have to be ratcheted higher in a hurry, the risk of defaults rises too. That would be occurring at one the least opportune times economically, with a looming Brexit playing havoc with growth. Shares of FTSE banks with little UK exposure or buttressed by wider geographical diversification, chiefly Standard Chartered and HSBC, have outperformed Lloyds, RBS and Barclays this year for that reason.

The broader picture is that ten years on from the beginnings of the financial crisis in Britain, whilst banks have gone a long way to restoring their financial health and redeeming past misconduct, there’s still a long way to go, and it shows. That’s why, even if the end of the low rate era could be predicted, if when or when it comes, investors are signalling they don’t expect all boats to be lifted immediately. 

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