[image 1] An intriguing fact that, I must admit, I hadn’t realised until recently is that the Bank of England introduced the first centrally set interest rate in 1694. And it was set at six per cent, suggesting that for all of the economic activity over the past 313 years, we have more or less been going round in circles, at least as far as interest rates are concerned.

This month, I’m looking at an event that happened much more recently, but which appears to have had a direct, and beneficial, effect on the UK economy. Black Wednesday, 16 September 1992, was the day when sterling was unceremoniously dumped out of the European Exchange Rate Mechanism (ERM).

For those who don’t remember this strange beast, the ERM was the system of interlinked European currency values that led – after a series of adjustments reminiscent of the Ugly Sisters trying to squeeze their oversized feet into Cinderella’s glass slipper – to the creation of the euro.

The grand plan

The idea was, of course, that the ERM would smooth the path to a single currency, by encouraging all of the EU’s member governments, including our own, to adopt economic and fiscal policies that would see their economies start to converge. Some chance! The UK Government was never more than lukewarm to the idea, and not too many tears were shed across the political spectrum when the pound and the ERM parted company.

However, it is instructive to look at the consequences of sterling’s departure from the ERM. There is general consensus among economists that being outside the ERM, and subsequently the euro, has given successive Chancellors greater room for manoeuvre than their European counterparts, and the facts seem to bear this out.

The latest piece of research carried out by Halifax Financial Services suggests that the period since the pound’s ejection from the ERM has coincided with a sustained period of economic outperformance. The UK economy has grown for an unprecedented 60 successive quarters (a record unique among OECD members). And in comparison with the 15 years prior to September 1992, the economy has been more stable and shown signs of faster growth, while UK interest rates and inflation have generally been lower and less volatile.

This has been seized upon joyously by one Mr G Brown, late of No. 11 Downing Street, who has rarely wasted on opportunity over the past decade to draw attention to UK Plc’s ‘sound finances’.

As Tim Crawford, economist at Halifax Financial Services, observes, ‘The UK’s new-found economic stability was the dream of both the public and policymakers during the turbulent 1970s and 1980s.’

But it is also interesting to note the underlying reasons for the Black Wednesday crisis. It was triggered by a rapid fall in the US dollar relative to the deutschmark, and since the pound was tied to the D-mark via the ERM it was being pumped up to unsustainable levels.

Currency speculators sought to benefit from this ‘one-way bet’ and the Government of the day spent £27 billion of reserves trying to support the pound (although the Treasury calculates that the ultimate loss was a mere £3.4 billion!).

Sounds familiar?

To cap it all, the pound was sitting at around US$2 just before Black Wednesday.

If that sounds a familiar scenario, there is a key difference with the current period of dollar weakness – the pound is no longer tied into a currency mechanism that keeps it artificially high (or low).

However, this does not necessarily mean that having an ‘independent’ pound is a guarantee of prosperity. As Tim Crawford points out, ‘While the pound’s ERM departure proved to be a catalyst for the UK’s much improved economic performance, we cannot conclude that the previous cycles of economic boom and bust have been eradicated. Economic policymakers will need to remain vigilant if the next 15 years are to prove as successful as the past.’

This article is from the October 2007 issue of What Investment.