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With the Bank of England slashing interest rates to 3.75% this month – the sixth cut since August 2024 – UK banks are in the spotlight. As a stock I’ve been considering for some time, I’m particularly interested to see how Barclays (LSE: BARC) shares fare.
More cuts loom in 2026, possibly reducing to 3.25% or lower by mid-year, as inflation cools. And here’s where I’m concerned: banks like Barclays live off the spread between loan rates and deposits (net interest margin, or NIM). Falling rates squeeze that spread, potentially hurting profits. Barclays’ Q3 showed NIM holding at 3.1%, but analysts warn prolonged cuts could shave £1bn+ off group income next year.
So, what happens to the share price?
Short term, the price might dip as much as 20% if NIM compresses faster than expected. But the shares have climbed an incredible 75% this year and are still trading with a forward price-to-earnings (P/E) ratio of only 8. So even a sharp correction would only mildly dent the recent growth.
What’s more, a strong rebound could follow if non-interest revenue improves. The bank’s investment and wealth management arm accounts for 40% of profits and typically thrives in volatile markets.
Weighing up the pros and cons
Supporting the bullish narrative is Barclays’ diversified business model which could offset NIM squeezes and drive rebounds. On top of that it has a favourable dividend policy with £1bn+ in buybacks planned.
That said, the cons hit hard on the profits front. Banks thrive on the spread between loan rates and deposits, so compressed NIM could potentially dampen 2026 earnings and wipe out much of this year’s gains. Loans also present a risk: in Q3, the bank reported £632m in loan impairments.
The overall UK bank sector
If the economy slows some more, bad loans could spike further, adding risk to the entire UK banking sector. Not to mention regulatory headaches like the recent motor finance scandal. Lloyds and NatWest are in a similar position, so the broader UK banking sector faces a potentially volatile year ahead.
With a higher 3.5% dividend yield, Lloyds does offer some benefits over Barclays — but it also looks pricier, with a higher P/E ratio. Natwest, on the other hand, has a fairly low P/E ratio and a decent 3.8% yield. However, it hasn’t enjoyed the same impressive growth as both Lloyds and Barclays this year.
Final thoughts
Overall, Barclays may be appealing to patient dividend hunters like myself — if we’re willing to weather NIM risks. However, it should only be considered as part of a diversified portfolio. Investors should also consider some potential rate-cut beneficiaries like housebuilders or high-yield insurers. A few that come to mind include Persimmon, Barratt Redrow, Phoenix Group and Legal & General.
It may also be worth exploring the mid-cap FTSE 250 index. Falling UK interest rates benefit such mid-caps by slashing borrowing costs for these often-debt-reliant firms, boosting margins and freeing cash for growth or dividends. Historically, such stocks outperform large-caps after rate cuts, as seen in past cycles, thanks to their cyclical housebuilders, industrials, and consumer plays that thrive on cheaper mortgages and spending.
