Sterling too strong for its own good.

Through the summer of 1992, there had been constant speculation that the pound could not survive the artificially high 2.9500 central rate it had versus the Deutschemark as part of the Exchange Rate Mechanism of the European Monetary Union.

The Bank of England was constantly being forced to intervene one way or another to shore up the currency which was under virtual siege. It was clear to every trader that the UK was going to continue to suffer unless there was a devaluation created naturally by market forces.

I had been managing a team of four traders who were responsible for the banks positions together with client and proprietary orders for a few months and the whole thing was generating a great deal of interest both inside and outside the bank.

Initially, even then, the UK had showed a certain scepticism towards a more integrated EU (EC as it was then). It refused to join the ERM yet maintained a policy of unofficially “shadowing the Deutschemark which was the paragon of anti-inflationary monetary policy and was much admired by the Chancellor Nigel Lawson and his predecessor Geoffrey Howe. The Cabinet was split over membership and when John Major took over as Chancellor in 1990 he managed to persuade Margaret Thatcher, against her better judgement, to join.

Economic Conditions require a weak pound

With interest rates at 15% and an inflation rate at three times that of Germany it was not the best time to tie the pound to the Deutschemark. In fact, it could be argued that despite her command of Foreign Policy and an iron will, Mrs Thatcher had a weakness when understanding even the broadest basics of the economy.

Through the summer I had been managing several in-house positions on behalf of the bank’s proprietary trading team who were short of Sterling. I attended several meetings of the team when they were discussing the mechanics of their positioning and they feared for not only the pound but also the Italian Lira since Italy was in a similar position to the UK.

It was universally agreed that there was very little risk of a Sterling recovery and it was simply a matter of time before the dam broke.

On the Friday before the fateful week began, I received a call from the Head of Treasury, warning me that the bank’s base case had been upgraded and that it was expected the UK Treasury would be forced into some action the following week. That could even lead to a General Election but whatever happened he was confident that the bank was positioned correctly and also confident that my team could deal with the outcome. I was filled with dread and a certain amount of excitement about what was to come.

Tension Builds

When my colleague and I arrived at the bank on that Sunday evening to prepare for the start of trade in Asia, there was a palpable feeling of tension throughout the market. The Bank’s night desk had, in a few short months, created something of an aura of respect, particularly since we rarely got involved in the JPY a stance that was both appreciated and respected by the Japanese banks.

We had developed a money-making ploy that was possibly unethical but generally gave us a profitable start to the week. Once the market had opened in New Zealand (the first market to open on a Monday morning), we would call a bank and ask for a price in a reasonably small amount of Sterling, between one and two million pounds, usually versus the dollar but occasionally versus another European currency. In normal times this would create panic in the bank we called since they would suspect we knew something either form something that had happened in Europe they hadn’t been told about or a story from the Sunday newspapers. We would deal on their price, it made little difference what side we hit although we tended to hit what we perceived to be the weaker, less protected, side and sat back to watch what happened.

The bank we asked would immediately cover their position and most likely “go with us”. So, our position got magnified as the market got going. As liquidity improved, often mid-morning in Sydney we would close the position and take what was always a healthy profit.

This was not the week for such shenanigans but what happened next created the most memorable week of my career.

Tomorrow I will tell you how the week to end all weeks unfolded.

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