Thatcher warned Major about exchange rate risks before ERM crisis

Margaret Thatcher privately warned John Major that he was in danger of making a mistake of Churchillian proportions on exchange rate policy and risked pitching the British economy into recession, the cabinet papers reveal.

Her warning to her anointed successor as prime minister came 20 months before “Black Wednesday”, when the pound crashed out of the European exchange rate mechanism in September 1992.

The confidential 1992 cabinet minutes released by the National Archives on Friday show that the ERM crisis sparked an upsurge in Euroscepticism on the Tory backbenches and that opposition to the Maastricht treaty swelled to “about 100 Conservative MPs”. Minutes taken two weeks after Black Wednesday record that Major’s cabinet realised they were in danger “of getting into a position where the Conservative party was irrevocably split on this issue”.

The Tory opponents of ratifying the EU Maastricht Treaty, whom Major was to famously dub “the bastards” were to make his political life a misery for the remainder of his government.

The warning from Thatcher came in a private meeting in Major’s room at the House of Commons on 1 January 1990 – just five weeks into his premiership. The meeting was to explain to her why he believed her flagship policy of the poll tax was politically unsustainable.

But the confidential note for the record taken by Andrew Turnbull, who served as principal private secretary to both the prime ministers, shows that Thatcher immediately launched into an attack on Major’s handling of the economy.

“Mrs Thatcher said conditions in the economy were very tough indeed, and she urged early and large cuts in interest rates.

“A reduction of one per cent would not be enough. She believed there was a danger of creating a mirror image of ‘Lawson’ inflation – a recession created by excessively high interest rates created by a policy of targeting exchange rates (though in fact she did not mention the ERM explicitly,” recorded Turnbull in reference to the monetary system set up in preparation for the euro.

“She believed there was a danger of repeating Winston Churchill’s historic error of fixing the parity for the £ at too high a level.”

This refers to Churchill’s infamous 1925 decision, when he was chancellor, to return Britain to the gold standard at the prewar rate of $4.86 that led to depression, unemployment and the 1926 general strike.

“The prime minister pointed out that for Churchill’s policy to have worked it would have been necessary to secure actual reductions in the price level. The current situation was not remotely comparable,” continues the note for the record.

Major told Thatcher he agreed the economic situation was tough but warned “against snatching at an interest rate reduction at the first opportunity” and believed “the prospects for getting inflation down next year were good”.

But while Major did succeed in bringing down inflation, helped by the discipline of ERM membership, Thatcher’s warning that Britain had joined at too high a rate would be vindicated when Black Wednesday arrived. Britain spent more than £6bn on 16 September 1992 trying and failing to keep the pound within the ERM’s narrow limits. George Soros was dubbed the man who broke the Bank of England after making £1bn profit in the single day.

The cabinet minutes for 10 September 1992 show that Major had praised his chancellor, Norman Lamont, for “having shown great skill in dealing with a period of extreme turbulence in the currency markets which was due to international factors beyond the government’s control”.

However, the confidential minutes released on Friday show the next cabinet meeting on 17 September 1992 heard an extremely lengthy explanation by Lamont in which he blamed everything from a weak dollar to an impending French referendum on Maastricht, hints from German bankers that undermined the pound and even “injudicious remarks by some of the government’s own backbench supporters” which had combined to “devastating effect”.

Major summed up saying the cabinet “strongly supported the action which had been taken by the chancellor of the exchequer and welcomed the return of interest rates to 10%”.

During the ERM crisis interest rates had peaked at 12% and at one point it had been announced would increase to 15% but that had been withdrawn. The 17 September cabinet agreed that Britain would resume its ERM membership “as soon as conditions allowed”.

But the minutes show just how long a week in politics can be. At the cabinet meeting on 24 September 1992 the confidential minutes show there had “been a sense of relief amongst Conservative MPs that the pound had left the ERM and that interest rates were down.

“There was considerable hostility towards re-entering the ERM. which was not confined to those normally sceptical of the benefits of European Community membership,” record the minutes.

“Opposition to the bill to ratify the Maastricht Treaty had grown; about 100 Conservative MPs did not currently support it. Eight MPs had indicated they would not support the government in the vote on the motion that night. It would be a mistake to offer any concessions in response to such pressures ... If the United Kingdom did not ratify and thereby stopped the treaty coming into force, it would no longer be able to play a significant part in the future development of Europe.”

The depersonalised minutes of the cabinet discussion presciently record “the government therefore had to avoid getting into a position where the Conservative party was irrevocably split on this issue”.

One member of Major’s cabinet, Ken Clarke in his memoir, Kind of Blue, says that “the ERM crisis had put a match to the dry tinder of resentment that backbench and grassroots Conservatives continued to feel about the fall of Margaret Thatcher two years earlier..... Black Wednesday had opened the Eurosceptic floodgates.”

To that extent it also marked the political moment that the movement that led to Brexit became went mainstream among Tory MPs.