Is Lloyds Banking Group plc on the cusp of a stunning recovery?

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Lloyds

Market activity during the fourth quarter has so far been favourable for embattled financial giant Lloyds Banking Group (LSE: LLOY).

The 'Black Horse' bank has seen its share price rise 9% since start of October, touching its highest since late June in the process. And while the firm remains at a significant discount to pre-referendum levels, I believe Lloyds' performance is still quite remarkable given the murky outlook for the British economy.

Indeed, I reckon the bank may struggle to gain further upside as the trading environment becomes more difficult for Lloyds in 2017 and beyond.

Dire warnings

Stock pickers have been piling into the stock as data following the Brexit vote have been, largely speaking, much better than expected.

Indeed, GDP data released on Friday showed that the UK economy expanded 0.5% during July-September. Many analysts either side of the referendum had predicted an economic contraction in the third quarter, leading to a technical recession by the close of 2016.

But that's not to say Britain's economy is on course to hit turbulence in the months and years ahead. Indeed, Chancellor Philip Hammond announced in this week's autumn statement that the government needs to borrow £122m more than it had initially anticipated back in March.

Meanwhile, the Office of Budget Responsibility said that it now expects the British economy to expand just 1.4% in 2017 -- down from its prior estimate of 2.2% -- reflecting the difficulties associated with Brexit. And expansion of 1.7% is now forecast for the following year, a cut from March's 2.1% estimate.

Cheap but chilling

At face value, some would argue that the risks created by a troubled economy are currently baked into Lloyds' share price. There is certainly some logic to this argument: the bank trades on a P/E ratio of just 8.9 times for 2017, some distance below the FTSE 100 forward average of 15 times.

I do not share this 'glass half full' approach, however, and believe Britain's journey into a post-EU landscape could very well result in prolonged bottom-line problems. The City expects Lloyds to follow a 16% earnings dip in 2016 with a 6% fall in 2017. And hopes of any earnings turnaround beyond this period are highly speculative at this time.

And this is not the only risk facing Lloyds, of course, as the bank grapples with a steady swell in the PPI bill. The company squirreled another £1bn away during the third quarter to cover these costs, taking the bill since the saga began to £17bn. And a proposed 2019 deadline for new claims leaves plenty of scope for further sizeable penalties.

And Lloyds' share price could come under significant pressure should the firm fail to meet City expectations of tasty dividend payments.

For the current year Lloyds is expected to pay a 3.1p per share dividend, creating a 5.3% yield. But a range of issues, from the aforementioned economic ripples and PPI problems through to Bank of England warnings over possible dividend hikes by UK banks following July's liquidity injection, could see Lloyds fail to meet such heady predictions.

I believe there is plenty of trouble brewing that could cause Lloyds' share to reverse again.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.