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The lingering effects of the pandemic continue to hurt UK shares, particularly high interest rates. Despite the Bank of England making several rate cuts this year, rates remain higher than expected due to stubborn inflation.
This puts pressure on borrowers and reduces consumer spending, which naturally has a knock-on effect for businesses. But not all UK shares suffer under higher rates. Among those sectors that benefit are banking, insurance and certain consumer staples.
For investors looking to benefit from high interest rates, I’ve uncovered two examples of strong dividend shares worth considering.
Lloyds Banking Group
When interest rates rise, banks like Lloyds (LSE: LLOY) stand to gain as their net interest margin widens. This means the difference between what they pay on deposits and what they earn from loans improves. Given the bank’s heavy reliance on UK mortgages and personal lending, that income boost can be significant.
But don’t get too carried away as higher borrowing costs can also burden customers, leading to defaults. Plus there remains a risk of legal expenses from the motor finance probe – a threat lessened by a recent court ruling, but whose shadow still lingers.
So far this year, the share price is up 51%, reflecting renewed investor confidence. In its latest earnings, revenue came in at £24.78bn with an operating margin of 24.8% – not bad for a retail lender. It has managed to maintain a solid dividend with a yield of 4.11% and a payout ratio of 50%, suggesting strong earnings to cover payments.
Legal & General Group
Insurance companies like Legal & General (LSE: LGEN) are another group that can benefit in a high-rates environment. They typically hold sizeable investment portfolios, and higher yields translate into better returns from their asset base.
The company has businesses spanning pensions, asset management and life insurance, making it well-positioned for rate-fuelled income growth. The stock yields a generous 8.34%, and with several decades of consecutive dividend payments, it boasts a solid track record.
Unfortunately, weak earnings mean it now has a whopping 540% payout ratio and is relying on reserves to cover dividend payments. Fortunately, its forward price-to-earnings (P/E) ratio of 12.7 suggests earnings are expected to improve significantly.
The flip side of high exposure to markets is vulnerability to volatility. Policy-driven market swings or falling asset prices could materially impact L&G’s income and share price. Considering its already thin insurance margins, there is some risk to take into account.
Long-term potential
Higher interest rates may threaten consumer-facing stocks, but sectors like banking and insurance offer potential for growth in such environments. Lloyds Banking Group benefits from rising margins and payment via a solid dividend, while Legal & General offers income through its investment-heavy model. However, neither is without risk.
That’s why diversification is key. Balancing exposure to banking and insurance with some defensive sectors can help manage the ups and downs. Yes, interest rates may still fall (negating the growth case), but their strong balance sheets, focus on pricing power and reliable income remain a smart foundation for long-term investors.
