1. Sector Landscape and Outlook
 

With the region steering through the transition to move out of the EU, which ends on 31 December 2020, the early indicators show that the UK economy is picking up; but the risk to global growth has increased in the recent past, owing to Coronavirus outbreak. PM Boris Johnson has huge infrastructure plans, and banks are likely to play a vital role in financing the UK economy as it is expected to shrug off the Brexit woes.
 
  
 
Let’s take a detailed look at the key trends which are impacting the sector.
 
Bank of England maintained a status quo: The bank of England is the apex authority in the UK which controls or direct the interest rate via its Monetary Policy Committee. The primary target of monetary policy is to manage inflation and provide support to the employment and thereby help in achieving economic growth. The apex bank maintained a status quo in the bank rate, which is the key policy rate despite a general expectation of the cut. The apex bank maintained a status quo and held the bank rate at 0.75% in its January 2020 policy meeting despite slowing economic growth and lower than targeted inflation. The low and stable employment rate, an uptick in employment growth and an expectation of pick-up in economic activities in the near-term gave the BOE confidence to maintain the status quo.
 

 
Inflation is below the central bank’s target:  The central bank set a target for inflation at 2%. Since July 2020, the rate of inflation was continuously moving southward and reached 1.4% in December 2019 (lowest since October 2016), thereby putting pressure on the monetary authority to take corrective measures.  However, January 2020 inflation number came at 1.8% (highest in the last six months) owing to a rise in prices of gas and electricity; fuels and lubricants; and clothing.
 
Employment uptick eased the pressure on the regulator: In Q4 2019, the UK employment rate reached a record high of 76.5%, up 0.6 percentage points over the year and 0.4 percentage points higher on the previous quarter. An uptick in the employment number provided the base for the apex bank’s decision to hold the key policy rate. Additionally, the unemployment rate was estimated at 3.8%, 0.2 percentage points lower than a year ago and 0.1 percentage point lower than a quarter ago. Between this period, the number of unemployed people was estimated at 1.29 million, which is 73k lower when compared to a year ago and 580k lower when compared to five-year ago. Average weekly earnings in Great Britain had moderated in Q4 to 2.9% for total pay and 3.2% for regular pay.
 

 
Growth touched zero in the last quarter of 2019: In February, Office of National Statistics had released a quarterly estimate for the Q4 ending December 2019, which suggested that the economic growth touched zero in the quarter, following 0.5% increase recorded in Q3. Also, the GDP was estimated to have grown at 1.4% in 2019, slightly above from 1.3% in 2018. It was noted that the GDP was volatile in 2019, reflecting the changes in Brexit dates to some extent. In 2019, the underlying momentum in the UK economy showed signs of slowing, and on an average, the quarterly GDP growth was between 0.2% to 0.3%.
 
Mortgage approval at the highest in last three years, while business loans remain a drag: January 2020 recorded the highest mortgage approval since February 2016 which suggest that UK housing space is finally coming back on track. Mortgage approvals surged 4.4% in January 2020 to 70,900 against December 2019 while the approval of remortgage also up 3.9% to 52,100. However, consumer credit seems to be struggling for growth trigger as it grew 6.1% in January 2020. The growth in consumer credit is hovering around the same level after it plummeted from a peak of 10.9% in late 2019. Brexit seems to be one crucial factor behind this slower growth as sentiments have been jolted since the referendum took place in June 2016. A friendly future trade agreement between EU and UK would lift the consumer sentiment and boost the credit offtake in the consumer credit space. Meanwhile, business credit offtake in January 2020 was at 0.8%, the lowest level since July 2018. Within this, the growth rate in credit offtake among large businesses and SMEs slumped to 0.9% and 0.5%, respectively.
 

 
After understanding the key trends, let’s ponder upon the outlook of the sector.
 
Exception of rate cut following Coronavirus outbreak: While the economic activities were appearing to be coming back on track post the Brexit decision such as inflation inching towards the central bank’s target, improvement in PMI etc., an outbreak of Coronavirus is throwing everything off track. It is taking a heavy toll on the economies and the markets across the globe. To counter the effect of the deadly virus, the US slashed the key policy rate by 50 basis points, paving a way to other monetary authorities to take corrective measure to help support the economy and protect it from any negative impacts. The governor of the Bank of England, Mark Carney, had suggested that the bank would cut down on interest rate, so that any potential adverse impact on the economy could be slowed down. This policy action of slashing rates is important as it will be a stimulator for the aggregate demand, rather than the aggregate supply in the economy, which is currently taking a direct hit from the coronavirus outbreak, as companies are unable to streamline their supply chain processes. This is also something that the Monetary Policy Committee, which is in charge of taking interest rate decision in the country, will deliberate upon as they meet before the next interest rate decision announcement. Since coronavirus has dampened global growth at least for the first quarter of 2020, the anticipated pick-up in the UK economy could be pushed out further, thereby increasing chances of a bank rate cut in the upcoming meetings.
 
Credit growth is expected to pick up in the later half, but the impact of external factors remains a challenge: Overall credit growth is expected to remain tepid in the first half of the year, owing to coronavirus outbreak and cautious consumer behaviour. However, mortgage approvals data in January was encouraging as it reached the highest since February 2016. An expected stabilisation in the coronavirus outbreak across the globe in the second quarter is likely to ease the uncertainty. Also, a favourable trade deal with Europe would improve a lot of overhang on spending and investment decisions for businesses as well as households. Also, UK banks have responded to the liquidity need of the businesses that are facing detrimental consequences due to coronavirus, and short terms loans and overdrafts are being released. Presently, the credit growth picture for the region is more skewed towards the second half when some uncertainties fade away. 
 

2. Investment Theme and Stocks under Discussion (LLOY, RBS, VMUK and STAN)

 
After understanding the key trends of the sector, let’s take a detailed look at four banks in terms of their outlook and performance. To gauge the potential of the banking stocks, we have used ‘Excess Earnings Methods’. Excess Earnings Method discounts the company’s future earnings which it is expected to generate above a required rate of return or cost of equity.
 
 
Fig 9: Relative performance of the stocks under discussion in the last 1 year (Indexed to 100)
 
 
 1. LSE: LLOY (LLOYDS BANKING GROUP)