In summer 1990, British Prime Minister Margaret Thatcher was a reluctant convert to the cause of joining Europe’s exchange rate mechanism. Persuader-in-chief was John Major, whom she appointed chancellor of the exchequer after the fallen-from-grace Nigel Lawson, her earlier favourite, resigned in October 1989. Thatcher told Hans-Dietrich Genscher, Germany’s foreign minister, in July 1990 that the UK ‘wanted to avoid a row in the Community.’ Britain had agreed to go further than she herself considered necessary or wise, ‘by proposing a common currency and a European Monetary Fund.’ She acknowledged the risks: ‘A single currency simply did not make sense and would not be accepted by the British parliament.’
Genscher said a future European Central Bank would be as independent as the Bundesbank. Foretelling pressures that would befall the German central bank 25 years later, Thatcher told Genscher she ‘would have much more confidence in the discipline of the D-mark, based on the historic aversion of the German people to inflation, than in a central bank where Germany might find itself out-voted.’
Attention in August and September centred on the prime minister’s insistence of an interest rate cut to 14% from 15% to coincide with the ERM move: Thatcher’s prize for giving way on Europe. Kenneth Baker, the Conservative party chairman, tried to dissuade her from joining. She told him: ‘Kenneth, I have secured a 1% cut and when we join we will be able to adjust the value of sterling. I have been assured that we will have that flexibility.’
Thatcher’s interest rate view diametrically countered that of senior officials. Eddie George, the hawkish Bank of England deputy governor, stiffened the recommendations of Robin Leigh-Pemberton, the ERM-supporting governor. Both warned against over-hasty easing. On 3 October Major, Leigh-Pemberton and other officials met to discuss Thatcher’s request for a rate cut to accompany the ERM entry announcement, scheduled for 12 October. (The decision to advance the statement to Friday 5 October, with entry taking effect on Monday 8 October, was made only on 4 October).
Major said he had argued for a delayed cut. George warned that a simultaneous reduction would undermine the strategy of joining to show ‘commitment to firm monetary policies’. Terry Burns, permanent secretary to the Treasury, said cutting interest rates just before entry was ‘rather like the stag night before a wedding’. Leigh-Pemberton said he did not like to ‘take the dividend before the profit’. He repeated the phrase in a strongly worded personal letter to Thatcher on 4 October, published here for the first time. George had prepared a steely speaking note which warned that, if the government gave a ‘weak policy signal’ by cutting interest rates early, there was a ‘small chance on this scenario of disaster – with a fall in the exchange rate putting upward pressure on interest rates.’ Leigh-Pemberton’s letter said, ‘There is a strong chance that such a move would produce downward pressure in the exchange market… there would be a chance, that we could not ignore, that we would have to reverse the interest rate cut.’
The final decision was taken on 4 October at a meeting between Thatcher, Major and senior officials including George; Leigh-Pemberton was absent from London, who was travelling to Tokyo. George emphasised the governor’s letter. Thatcher argued for acting simultaneously. Her view prevailed. The cabinet meeting at 10.30am did not discuss the ERM.
Communications at home and abroad ahead of the announcement – at 4pm on 5 October – were executed with precision and prudence. ERM rules prescribed that the UK should discuss the modalities of membership, including the exchange rate, with Germany, France, Italy and other partners. For the UK, though, this was a sovereign decision. The Treasury and the Bank of England peremptorily informed the rest of Europe in a series of pre-announcement phone calls.
Senior ministers were not told of the move, for fear of premature leaks. A Treasury note on the 5 October timetable records an option for Major to inform ‘selected cabinet ministers’ shortly before 4pm, adding a cautionary note: ‘Or is this too risky?’ The cabinet did not meet for nearly two weeks afterwards. When it did convene, on 18 October, Major told ministers, with scant regard for the facts, ‘It had been proper and necessary to reduce interest rates and the governor of the Bank of England had supported the move.’
Britain’s entry to the ERM had been under sporadic review for a decade. But the decision to join was a scrambled, clandestine act guided by deeply contradictory motivations, with little consideration of imminent German monetary tightening, and with leading partner countries and most of the cabinet kept uninformed.
Unsurprisingly, in the following two years, UK plans went awry.
David Marsh is Managing Director of OMFIF.