It is just over 30 years since Britain left the Exchange Rate Mechanism (ERM) in what became known as Black Wednesday. Looking back provides interesting parallels and certainly puts today’s interest rates of sub 5% in perspective.
September 16, 1992 was a significant turning point in Britain’s political history. It could well be that, thirty years on, the Kwasi Kwateng’s ‘fiscal statement’ of last Friday, 23rd September will be seen as a similar turning point.
September 16, 1992 was the day when interest rates rose twice from 10% to 12% in the morning then up to 15% in the afternoon. For those struggling with a base rate raise approaching 4%, the thought of 15% is enough to turn most people grey overnight.
Britain joined the ERM in October 1990 as a forerunner to joining a single European currency, which would become the Euro. The aim of the ERM was to stabilise exchange rates in order to keep inflation low and make trade easier between countries.
All members of the ERM had to keep their currency value within a band linked to the German Deutsche Mark and for the UK this was set at £1 = DM2.95. If the exchange rate went below DM2.773 the British government had to do something to bring it back up such as buy sterling and/or raise interest rates.
The economy was on a downward spiral then as it appears to be now, with inflation in September 1990 at 8.2% with interest rates increasing. Unlike now however, although our inflation rates are predicted to rise to 13%, our house prices continue to rise by almost 10% per annum whereas back in 1992, house prices were falling.
Another big difference in 1992 was that most people had variable mortgage rates, so monthly payments for vast swathes of the population, were rising each time interest rates rose – as were arrears and repossessions.
Now 83% of people are on fixed rates, according to the Bank of England, so while they may have a payment shock when they come to remortgage, many people’s mortgage payments are protected to an extent for the time being.
The recession in 1992 also caused unemployment to rise whereas we still have historic lows in unemployment for the time being.
By joining the ERM it was hoped inflation would come down but it took until 1992 for inflation to significantly decrease and by September 1992 it had finally dropped back 3.1%. But sterling was nearing the lower band of the ERM.
On Tuesday September 15th 1992, billions of pounds were sold in foreign exchange markets by currency traders and the Bank of England used foreign currency reserves to try to buy the pounds but couldn’t keep up.
Raising interest rates to 12% then 15% on the Wednesday did not help either and the pound dropped below the required ERM level so Britain pulled the plug and left. The following day the interest rate went back to 10%.
The pound was now floating freely outside of the ERM and continued to slump reaching a low in early 1993 before slowly starting to rise. Interest rates could be lowered and Britain started edging out of recession.
The news this week of the pound falling against every currency and reaching forty-year lows against the dollar is more reminiscent of those times than we would like to be.
1992 Chancellor, Norman Lamont, said it had been a “difficult and turbulent day” and that “massive speculative flows continue to disrupt the functioning of the ERM” leading to the decision to leave the ERM.
Black Wednesday is an interesting historical comparison, coming as it does, almost exactly thirty years before the turmoil that we are currently faced with. While there are some elements that put us in a stronger position than we were thirty years ago, such as high employment and high numbers of fixed rate mortgages, we need to hope that inflation recedes and the pound rises as rapidly as it did then.
It feels very much that, once again, we are in unchartered waters. Let’s hope that the history books in another thirty years’ time will show the skilful chartering out of the choppy times ahead.
Paul Brett is managing director, intermediaries at Landbay
