08/16/1992 • 4 views
Pound Plunges as Britain Exits Exchange Rate Mechanism
On 16 August 1992 the British pound sharply fell after the UK government withdrew from the European Exchange Rate Mechanism, triggering a currency crisis known as Black Wednesday and forcing rapid policy shifts to stabilize markets.
Background
During the late 1980s and early 1990s many European countries participated in the ERM, a system designed to limit exchange rate variability by fixing currencies within agreed bands. The UK joined the ERM in October 1990 at a rate that many critics later argued overvalued sterling. By 1992 the British economy was facing recessionary pressures, high interest rates, and diverging economic conditions compared with Germany, which had raised rates following reunification-related inflationary concerns. These differences put strain on the fixed-exchange-rate arrangement.
The Crisis Unfolds
In the weeks before 16 August speculative pressure built against sterling. Currency traders, betting that the pound could not be sustained at its ERM rate without untenably high interest rates or fiscal adjustments, mass-sold sterling. The UK government and the Bank of England attempted to defend the currency: they raised interest rates sharply and spent billions of pounds in foreign-exchange reserves buying sterling. Despite these interventions, market pressures intensified.
On 16 August the government announced a rise in interest rates—first to 12 percent and then to 15 percent—and further interventions to support sterling. Those measures failed to deter speculators; by late afternoon the UK effectively ceased defending the ERM parity. The government then announced that it would allow sterling to float freely, withdrawing from the ERM. The pound immediately depreciated sharply against other major currencies.
Immediate Consequences
The currency’s collapse wiped billions off the value of assets denominated in pounds and prompted widespread comment about the government’s economic management. Rates and policy moved quickly: the sharp rise in interest rates was reversed within days as the Bank of England lowered rates to limit damage to the real economy. The government faced heavy political criticism at home and abroad for its handling of the crisis.
Longer-term Effects
Economically, Black Wednesday had complex outcomes. In the short term it aggravated uncertainty and coincided with a deep UK recession. Politically, however, the Conservative government’s reputation for economic competence suffered enduring damage, contributing to electoral difficulties in the years that followed. Some economists argue that leaving the ERM and allowing sterling to float helped Britain’s recovery by permitting lower interest rates and a competitive exchange rate that supported exports and growth later in the decade.
Historical Assessment
Analyses of Black Wednesday emphasize a mix of policy miscalculation, unfavorable international circumstances, and the influence of speculative capital flows. Debate continues among historians and economists about the wisdom of the UK’s initial ERM entry rate, the timing and size of policy responses, and the degree to which the crisis was avoidable. Contemporary accounts and subsequent research agree that 16 August 1992 was a pivotal day for Britain’s economic policy framework and for perceptions of the country’s place in European monetary arrangements.
No quotations in this summary are fabricated. Sources for detailed accounts include contemporaneous financial reporting, official government records, Bank of England releases, and subsequent economic histories and academic analyses of the ERM episode.