Lloyds (LSE:LLOY) shares are up ever so slightly over the past 12 months. However, throughout most of the year the stock has pushed downwards until a recent rally.

So what’s next for 2023? Well, I’m broadly confident that the stock will continue its rally and City analysts suggest the dividend might be due for a much-anticipated rise. Let’s take a closer look at why I’ll buy more of this stock.

A multi-billion pound tailwind

Interest rate sensitivity is providing Lloyds with a huge tailwind. The Bank of England (BoE) base rate is now 3.5% and analysts see it hitting 4%, or higher, in 2023.

This means that net interest margins (NIMs) — the difference between lending and savings rates — are growing. The bank said the NIM was forecast to reach 2.9% by the end of the year, and it could grow further in 2023.

But there’s another bonus here. Lloyds, like other banks, also earns interest on its central bank deposits. And the higher rates gets, the more Lloyds earns.

Analysts have highlighted that for every 25 point basis hike, Lloyds will earn around £200m in income from reserves held with the BoE.

So with the base rate up over 300 points in 2022, Lloyds could be pulling in around £2.5bn in extra revenue from its £145.9bn of eligible assets and £78.3bn held as central bank reserves.

But why Lloyds? Well, I’m picking the business for my portfolio because it has greater interest rate sensitivity than other banks. This is due to its funding composition and business model. Unlike other banks, Lloyds doesn’t have an investment arm and is highly reliant on interest income from mortgages.

Bad debt?

The next few months could play out a few ways for Lloyds. In Q3, impairment charges soared to £668m from a release of £119m a year ago as bad debt concerns increased.

I’m hopeful that not all of these funds will be needed to cover the cost of debt turning bad, but time will tell.

There are some positive signs right now. Wholesale gas prices, a core feature contributing to this cost-of-living crisis, are falling considerably. European prices for delivery in February fell by 4.3% to €73.7 a megawatt hour on Tuesday.

Dividends

Shareholders have been keenly awaiting an increase in dividend payments. The stock currently has a 4.6% dividend yield, and that’s pretty good. I see Lloyds as a pretty safe bet. So to get 4.6% a year in dividends alone is a big bonus, as far as I’m concerned.

And, in spite of the tough economic outlook, City analysts are expecting a full-year dividend of 2.4p in 2022, rising to 2.7p and 3p in 2023 and 2024 respectively. The 2024 figure represents a 25% increase from the current dividend.

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

Motley Fool UK 2023

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