Michael Ezra

In defence of no-deal Brexit

In 1990 Britain joined the ERM (Exchange Rate Mechanism) of the European Union. This meant, in practise, that Britain pegged its currency, sterling (GBP), to a band relative to the Deutschmark, the German currency before the Euro. In 1992, with pressure mounting on sterling, it was becoming increasingly problematic for the government to keep the currency within its band and it had to keep selling foreign currency reserves to buy sterling to support it.

Eventually, on September 16, 1992, after relentless selling of sterling from speculators and others, the government had enough. They allowed the pound to come crashing out of the ERM. Sterling collapsed, speculators who bet against the government made a fortune – at the expense of the Bank of England – and the government under Tory Prime Minister, John Major, were left embarrassed. That day became known as Black Wednesday.

The initial effect was a substantial fall in GBP’s exchange rate, but a secondary, and very important effect, was that it allowed the UK government to cut interest rates, which they continued to do over the next few years. As a result, the lower exchange rate made British goods and services more attractive to businesses and individuals in other countries. The lowering of interest rates also meant that businesses could borrow money at a cheaper rate, and this stimulated growth and the economy. The mortgage rate also came down giving people more disposable income. This latter move greatly assisted a recovery in property prices which had fallen substantially from a peak a few years earlier in a recessionary period.

Meanwhile, Germany was hamstrung. Its own interest rates were high, and the government could not be competitive in lowering rates. Due, in part to the ERM, other European countries also had very high interest rates. The net result was that Britain had a competitive advantage to European countries which remained in the ERM.

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