Welcome to part two of our guide to The First Brexit. Today we’ll be getting into the details of the infamous (if you’re old enough) Black Wednesday. You’ll soon see why ERM was a fitting acronym for the confusion and chaos that occurred on Black Wednesday (as in erm, what were they doing?). For a recap of ERM and ECU, as well as a few tasteful music references, go check out part one.
Ask your average office worker and they might tell you every Wednesday feels like Black Wednesday; in fact, Black Wednesday refers to 16th September 1992 – the day the UK left the European Exchange Rate Mechanism (ERM). Margaret Thatcher, on the advice of then-chancellor John Major, had decided to enter the ERM in 1990, which meant the pound would be locked between exchange limits set against the German Deutschmark and other European currencies. According to a BBC report, the aim of the ERM move was to inherit German-style discipline, stability, low-inflation and prosperity in a time when the UK economy was sliding into recession.
The Dominos Begin to Fall
Unfortunately, it didn’t quite work out as expected; Margaret Thatcher lost her job soon after, and John Major became the captain in charge of a sinking ship of his own creation. High exchange rates, as a result of the ERM’s parameters, meant businesses struggled to sell their goods abroad. Due to rising reunification costs in Germany, the European economic situation took a turn for the worse – the German central bank raised interest rates to slow inflation (higher interest results in higher cost of borrowing and, thus, less disposable income, which slows demand for goods and decreases inflation). Maintaining stability was Germany’s priority, while in Britain, the idea of raising interest rates would, above all, hit the UK’s housing market; a decision that was according to Bill Robinson (Special Advisor to the Chancellor 1991-93) “increasingly politically and economically unsustainable.”
High interest rates on the German Deutschmark led London’s traders to sell their pounds in favour of the German currency. The value of the pound fell as demand decreased and rumours of the UK leaving the ERM increased (although the government denied these rumours around three weeks before they did just that: “We are absolutely committed to the ERM,” said then chancellor Norman Lamont on 26th August 1992).
A meeting between the German Bundesbank and British politicians took place in which Norman Lamont asked for the German exchange rate to be lowered. Bundesbank officials refused. The pain of ERM membership was being felt acutely across Europe, with Italy suffering alongside the UK – traders began selling Lire in favour of the Deutschmark just as they had with the pound. The ERM required all members to keep their currency within the exchange boundaries, and as European currencies began to slide, money was being purchased by several countries’ central banks to fill the gap and maintain confidence. That was until the Bundesbank decided enough was enough. An ultimatum was given to the ERM member states – the German interest rates would be cut if Italy, Britain and other member states devalued their currency. While the Italians considered the proposal, John Major was quick to refuse such an offer. The Italians went ahead with a 7% devaluation, and the Germans cut their interest rates by 0.25%; traders assumed a British devaluation was next, resulting in more pounds being sold.
The Purge: UK Edition
Holding onto pounds suddenly became a risk on Wednesday 16th September. Speculators were the final nail in the coffin on Black Wednesday, with George Soros probably the most famous investor to take advantage of the events. Mr Soros sold a substantial amount of pounds while the price was high, with the intention of buying it back when the currency devalued. Words from Helmut Schlesinger (Bundesbank President 1991-93) in an interview from 15th September suggested the pound may be devalued; this acted as the touchpaper from which the fire sale of pounds would spread. In an attempt to stop the clearance sale, the Bank of England began buying back speculators’ pounds at the ERM rate in order to sustain value and confidence in the UK’s continued ERM membership – at a rate of “£2bn of sterling an hour,” reported the Guardian.
After spending several billion on ERM rate sterling (at the time this was the most invested by the Bank of England on such an issue – it’s now dwarfed by the 2007 banking bailout), the Bank of England decided that this tactic would not stabilise the currency; a rise in interest rates would be necessary. At 11am on Black Wednesday, interest rates rose from 10% to 12% in an attempt to stop investors from selling and to ease the pressure on the Bank of England. The investors smelt the desperation and reacted accordingly – George Soros saw the government’s reaction as the sign to “double up, to try to sell as much as possible.” For George and the other investors, clearly, they were doing something right if they could force the government to act. The result was another interest rate rise, this time to an unprecedented 15% (a remarkable 5% in one day) at around 2pm on Black Wednesday. Traders in the city were dumbfounded by the government’s reaction – what was obviously a move of desperation had been repeated.
It became clear – staying part of ERM was no longer feasible for the UK. A political bomb was about to be detonated and John Major’s policy to stay part of the ERM was directly in its blast radius. At 4pm, the Bank of England ceased buying pounds from traders and the gates were fully opened; the country’s central bank had lost confidence in its own currency. Cue the government ministers looking for someone to take the political bullet and announce the UK is leaving the ERM. At 7.30pm, chancellor Norman Lamont announced the UK’s suspension of the ERM measures to the press and a fall back to the 12% interest rate (special irony points for those who spotted a young David Cameron in the background of Mr Lamont’s announcement).
Ironically, the British economy did bounce back, and it flourished outside the ERM; Norman Lamont, however, did not. He was forced out of his role as chancellor in 1993, although John Major did fairly well after the debacle, lasting almost another five years until the Conservatives suffered their largest defeat in almost two centuries at the 1997 general election.
So ends the tale of the first Brexit – but the questionable goings-on between finance and politics continued; next week we look at how polling had a direct impact on the financial markets before the EU Referendum in 2016 (the real Brexit).
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