Final 12 months, the banking sector was the standout for share price positive aspects within the FTSE 100. Main corporations together with NatWest Group (LSE:NWG) and Barclays (LSE:BARC) virtually doubled in worth.

But regardless of this surge, I’m somewhat extra conservative in relation to the outlook for the 12 months forward on this space. Right here’s why.

Valuations

Don’t get me flawed, I don’t suppose banking shares are overvalued normally. But the explanation to purchase them as undervalued picks has now disappeared.

For instance, the Barclays price-to-earnings ratio has doubled over the previous 12 months, with it now slightly below 10. I exploit 10 as a benchmark for a good worth for this ratio. So the truth that a lot of the FTSE 100 banks at the moment are priced pretty leads me to conclude that sharp share price will increase in 2025 are extra unlikely.

Because the beneath chart exhibits, each NatWest and Barclays shares are at their highest degree in 5 years. Over the previous 12 months, Barclays jumped 72%, with NatWest up 82%. Though this reality alone doesn’t imply the shares are overvalued, psychologically it might delay some new traders. It’s tougher to persuade somebody to purchase a inventory at multi-year highs, as they’ve the human emotion of desirous to get a cut price.

Rates of interest

A change within the base rate of interest has a big impression on profitability for banks. Final 12 months, rates of interest within the UK and US stayed larger than many individuals anticipated. This was a key cause why the banking sector did so properly. Each NatWest and Barclays have giant retail banking operations. This implies they pay out curiosity on deposits however can lend out cash by way of mortgages and different loans. The distinction within the charge is the online curiosity margin for the financial institution.

Nevertheless in 2025, the UK, US and different nations might reduce rates of interest extra aggressively. This is able to be the case if inflation doesn’t spike larger in coming months. On this situation, internet curiosity earnings ought to fall. This is able to seemingly have a knock-on impression on the respective inventory costs.

Particular person issues

A number of banks are coping with particular points which might present a distraction this 12 months. For Barclays, it misplaced a authorized case in December regarding the potential mis-selling of automotive finance. There are different ongoing circumstances, however the potential reputational harm and compensation funds may very well be giant.

For NatWest, it’s the change on the high, following the resignation of Alison Rose amid a political scandal in 2023. Paul Thwaite has taken the helm, however traders will likely be watching issues intently to see how any technique adjustments play out in his first couple of years.

After all, I may very well be flawed with my viewpoint on the banking sector. Additional, simply because I don’t suppose the roaring returns of 2024 will likely be matched, it doesn’t imply I believe the shares will massively fall. I simply really feel different sectors supply traders higher alternatives as we begin the 12 months.