We face a succession of Black Wednesdays — but good things can come out of bad

Economists don’t usually put much store by dates but this week sees the 30th anniversary of one of the most important days in recent economic history, namely September 16th 1992. On that fateful Wednesday, sterling was ejected from the European Exchange Rate Mechanism (ERM), which tied the pound to other European currencies, with enormous economic and political consequences, some of which we are still living with today.

The events of that day were dramatic. Interest rates went up twice, first from 10pc to 12pc and later from 12pc to 15pc. Across the country, people panicked. Many mortgage holders, appalled at the realisation that they couldn’t possibly keep up their mortgage payments, posted the keys to their properties through the doors of their mortgage lenders.

On the second interest rate rise the stock market soared. Market operators realised that the game was up. We would have to leave the ERM. The result would be that not only would sterling come down but we would be able to operate with much lower interest rates. So it proved. Even interest rates of 15pc and massive official purchases of sterling couldn’t hold the exchange rate. By the evening we were out.

Nearly everyone who lived through that day could tell a personal tale of woe – including me. 

At the time I was a still youngish City economist working for HSBC. In the preceding August, having studied the events of 1931 when sterling had come off the Gold Standard, I came to the conclusion that we would be forced out of the ERM. 

I wrote a paper for circulation among our institutional clients which argued that interest rates would be increased to 15pc in a bid to stay in the ERM but we would be forced out and interest rates would then fall to something like 5pc. What’s more, far from being disastrous, this would lead to a strong economic recovery accompanied by low inflation.

This was a radical piece of economic research and my employer baulked at its immediate publication. I was due to go on a foreign holiday and I didn’t have time to talk it over with the key people in the bank before leaving. So I decided to defer the issue until I returned from holiday, hoping to persuade the bank that it would be okay to publish.

I flew back on September 16th. I turned on the radio to hear that we had indeed been forced out of the ERM after interest rates had been raised to 15pc. I was gutted. What would surely have been the greatest forecasting coup of my career had been scuppered. 

And apart from a few people inside the bank, no one would know just how my bold forecast had been vindicated. These events were a key influence in persuading me some years later to set up my own independent consultancy, Capital Economics.

Nevertheless, there was an immediate silver lining. In stages, interest rates were indeed cut drastically. In the succeeding months, in research notes and newspapers and on radio and television, I assiduously promoted my message that, contrary to establishment pessimism, our ERM exit would not bring on inflation and recession but rather a strong economic recovery, accompanied by low inflation.

This is indeed what transpired. Eventually, what had first been dubbed “Black Wednesday”, came to be known as “Golden Wednesday”. And I was recognised as one of the few who had foreseen this.

Several features of current economic and political reality have their origins on that day. The monetary authorities were traumatised by what had happened. Having earlier lost faith in the money supply as a way of controlling inflation, and now having failed to live with an exchange rate target, they were casting around for a new anchor for nominal values. What they hit upon, wisely in my view, was a target for the rate of inflation itself. With some subsequent modifications, this system continues to this day.

Moreover, anxious to sustain the credibility of policy in the financial markets, the government gave a more independent voice to the Bank of England. Full independence came a few years later with the arrival of the Labour Government in 1997.

The events of that day also had a profound effect in making public opinion more eurosceptic. The UK’s close involvement with this European scheme had brought us close to disaster. 

Despite all the earlier official protestations of how essential it was to belong, once we were outside we did perfectly well. Indeed, the following years were some of the most successful in modern times. This whole episode was an important factor in persuading most members of the public against us joining the ERM’s successor, the euro.

I suspect that the events of that day and the subsequent years also had a major effect on the popular estimation of the ability of economic forecasters. The establishment experts had got things spectacularly wrong.

This was to have an echo much later with the so-called “Project Fear” documents put out by the Treasury in advance of the EU referendum in 2016. These forecast dire consequences if we dared to vote to leave the EU. Some people may well have been cowed into voting Remain but I suspect that the dominant reaction was one of disbelief and even amused disdain – influenced by memories of what had happened on and after “Black Wednesday”.

But the most important consequence of that fateful day was that the Conservatives lost their reputation for economic competence. Even though the next five years brought sustained economic growth, the Conservatives lost the 1997 election by a landslide.

The coming months are going to bring great adversity and it is going to feel as though we are living through a succession of Black Wednesdays. But good things can come out of bad. Governments should never waste a good crisis. This is the time to set out the right path for policy – and to stick to it.

Roger Bootle is chairman of Capital Economics