This week 26 years ago, a speculator by the name of George Soros took on the Bank of England and won.
The day was 16 September 1992. Panic ensued from the pound dropping a little bit too much in value.
It triggered a massive sell-off in sterling. The Bank of England tried everything to avert disaster to no avail.
The UK government alone lost billions that day, just like many others in the market. Speculators selling the pound, on the other hand, made a fortune.
Soros “broke the Bank of England” as the folktale goes, which makes it sound rather more heroic than “he made a shedload of money betting the right way”.
Most others active in the markets that day mourn the events. As is tradition, the colour black was added to that day as 16 September 1992 is now referred to as “Black Wednesday”.
Brexit could throw up another of those black days.
If the UK leaves the EU without a deal, investors will trip over themselves to sell the pound.
Knowing what happened on Black Wednesday, how might Bank of England governor Mark Carney navigate Black Brexit Day?
I was too young to know what an Exchange Rate Mechanism was in 1992. “Black Wednesday” to me was just “Wednesday”.
Fortunately I can draw on the memories of more experienced colleagues who worked in the City at the time.
David Stevenson, investment director of Strategic Intelligence and Untapped Fortunes, sets the scene:
“I remember 16 September 1992 like it was yesterday.
“I was there – as a fund manager on the dealing desk (in those days, we did our own trading) when the pound went down through its ‘permitted’ limit on the ERM.
“My boss, who was also watching the screens, said ‘the pound’s broken down, that can’t happen’.
“I replied ‘it just has!’”
Chancellor Norman Lamont was quick to respond and whacked up interest rates from 10% to 12% to defend the pound, followed by a promise to hike rates further to 15%.
Back then there was no Monetary Policy Committee to make these decisions yet. The Chancellor of the Exchequer called the shots as the Bank of England was an official branch of the UK government.
But the markets wouldn’t be fooled. Investors didn’t think the aggressive rate hikes would do the trick.
Valiant as Lamont defended the pound, he had to throw in the towel later that evening when the Treasury had already spent £3.3bn hoovering up pounds on the markets.
The Chancellor pulled the UK out of the ERM and rates swiftly returned to 10%.
“The key point is the confusion this caused,” says David.
“For several hours, the markets hadn’t a clue what was going on – or likely to happen next.”
The day the UK left the ERM – sometimes referred to as the “first Brexit” – could be a lesson for an unorderly UK exit from the EU in 2019.
“Sure, a Brexit ‘no deal’ is looking less likely than a few days ago, according to the rumours.
“But it could still happen, which could prompt first a rise in interest rates, then a fall – or maybe vice versa!”
Forewarned is forearmed…
If the government, businesses and the Bank of England are doing some contingency planning, it couldn’t hurt if you did the same…
The man who oversaw the Black Wednesday crisis, Norman Lamont, reckons a Brexit deal would immediately lift the pound.
“I personally would not be surprised if after the negotiations are completed, and assuming they’re successful, sterling didn’t strengthen quite considerably.”
Markets would heave a sigh of relief. Most of the pressure weighing down the pound at the moment comes from all the present uncertainty around Brexit.
If Theresa May negotiates a deal with Brussels that Parliament deems acceptable, the pound is certain to go up.
But the opposite must be true as well.
If the UK government and the EU can’t reach an agreement that can win parliamentary approval – the Irish border issue in particular looks thorny – the pound could tumble hard and fast.
In that case, Downing Street will cable Threadneedle Street as the government is bound to send in the cavalry.
Like in 1992, the Bank of England will have to come to the pound’s aid.
But how would the Bank respond? It’s going to be pulled in two different directions at once.
Mark Carney, who’s agreed to stay on as Governor till January 2020, could copy Lamont’s playbook and hike rates immediately to defend the pound and keep inflation at bay.
Lamont raised the interest rate from 10% to 15% but then had to fold as the markets remained set on selling the pound.
A 5% hike in the current environment, however, might sort more effect.
With interest rates in the US, Europe and Japan still on the floor, the UK economy would become much more attractive compared to other developed countries.
In this scenario the UK would immediately become a saver’s paradise but the worst nightmare of households on a big floating rate mortgage, who would see their interest payments shoot up all of a sudden.
But if investors can’t be lured back to the pound with higher interest rates, Carney would have to cut rates again.
Another stimulus package would be forthcoming to give the economy a much needed lift.
Savers would then be back at square one while homeowners can sleep peacefully again at the prospect that rates will remain low for a long, long time.
Carney’s initial response to a pound sell-off on “Black Brexit Day” would probably resemble Lamont’s in 1992.
Investors familiar with Black Wednesday might be at an advantage if a no deal Brexit happens and we see a rerun of those events.
George Soros claims to have walked away from Black Wednesday $1bn richer, which proves a “black” trading day is never black for everybody.