Unforgettable trading moments - Black Wednesday

Unforgettable trading moments - Black Wednesday

Learn more about what happened in one of the grimmest days of Bank of England.

Here at Capex, we are trying to educate both future and active traders.In today's article, we will discuss the famous event commonly known as "The Black Wednesday."

The beginnings

It all started in the UK on September 16, 1992. At that time, the United Kingdom was part of the European Exchange Rate Mechanism (ERM) since 1990.

ERM was founded in 1970 as a mechanism designed to stabilize the European currencies when countries were preparing for the Economic and Monetary Union (EMU) and EUR implementations.

EMU was launched in 1992. To this day, it regulates fiscal and economic policies, monetary policies, and the EU’s common currency. It also manages the countries that adopted the euro. To be part of EMU, the states had to keep their currency's value within a specific range for a few years. However, the UK hadn’t made the cut due to a collapse in the pound.

The pound faced difficulties since the beginning of EMU’s accession process. At that time, the UK was affected by the dramatic depreciation of the US Dollar. Moreover, alongside Italy, it battled double deficits.

George Soros – “the man who broke the Bank of England” and his Quantum Fund

The Quantum Fund was established in 1969 by George Soros and Jim Rogers. The fund dealt with investments in public and private equity, foreign exchange, commodities, currency market, venture capital funds, and fixed income markets globally while holding its investments in energy, retail, and transportation.

A few months before Black Wednesday, George Soros managed to short-sell British pounds and bought German marks. The move brought him $1.8 billion. At that time, Soros believed that the rate and the inflation of the Exchange Rate Mechanism were too high, and because of this, the British interest rates conflicted with the assets' prices.

Now, fast-forwarding to September 15, 1992, we learn that the Quantum Fund started shorting the pound. The Bank of England was asked to sell pounds by the ERM. The next morning, on September 16, the Bank accepted two offers of 300 million pounds. But what the Bank didn't know was that the Fund was selling pounds much faster. The buying and selling process continued until Chancellor of the Exchequer, Norman Lamont, realized that the pound buying didn’t have any results.

A couple of hours later, the base interest rate increased to 12% from 10% to attract clients. Furthermore, the UK Government was planning to raise it as high as 15% to curb the pound from falling even more on the same day.

By the end of the day, Britain announced its departure from the ERM. The Chancellor also stated that the rates would remain at 12%, but they were back at 10% on September 17.

Repercussions. “White Wednesday”

All the events in Great Britain, which led to high-interest rates, and corroborated with the German low rates, resulted in a recession for the UK. As a consequence, the housing market collapsed, causing a significant number of businesses to flop.

While some believe that the country's international prestige suffered due to Black Wednesday, some Conservative Party members deem this day the economic push needed by England to survive. They refer to the forced ejection day as "White Wednesday" or "Golden Wednesday." The event led to an enormous waste of money, belittling John Major and the Conservative Party's economic management capacity.

Starting from 1997, under the leadership of Tony Blair, member and leader of the Labor Party, the unemployment rate and inflation began decreasing, leading to economic growth.

However, Black Wednesday somehow prevented the UK from more economic damage in the grand scheme of things, as Europe entered the sovereign debt crisis.

The European sovereign debt crisis occurred in 2008. It started with the collapse of the Irish banking system. Portugal, Italy, Ireland, Spain, and Greece followed soon after.

The crisis ended in 2012, but during the four years, it led to high government debt and bond yield spreads, plus the collapse of financial institutions.

By using the pound and not being part of the Eurozone, Britain could better cope with the situation by using monetary policy measures. Overall, Black Wednesday cost less than what some countries had to pay to be part of the Eurozone.

"Knowledge is power," like Sir Francis Bacon said a very long time ago. If you are interested in expanding your trading horizons and want to see how things work, we encourage you to search for past events from the financial world. Moreover, browse the Featured Articles and Market News sections on CAPEX.com to find daily news about the most important topics.

Do you need to check up on your knowledge regarding a particular instrument? Don’t worry! We have a Financial Dictionary, and a Trading Academy that can help you along the way.

Sources: investopedia.com, bbc.com, bloomberg.com


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