When the ERM had been set up in 1979 Britain declined to join. This was controversial, with the Chancellor of the Exchequer Geoffrey Howe who despite his economically 'dry' credentials was a convinced pro-European. Another chancellor, Nigel Lawson, was also a believer in a fixed exchange rate, although he was a mild Eurosceptic he admired the low inflationary record of Germany attributing it to the strength of the Deutsche Mark and the management of the Bundesbank. The Treasury followed a semi-official policy of Shadowing the Deutsche Mark. As the exchange rate was largely kept in place by the use of interest rates, then interest rates were set without the domestic economy in mind. This led to a couple of years of lower interest rates than would have otherwise been in place and so rising inflation.
The pressure came to a head in a clash between Margaret Thatcher's economic advisor, Alan Walters and Lawson - when Walter's claimed that the Exchange Rate Mechanism was "half baked". This led to Lawson resigning as chancellor to be replaced by his old protégé John Major.
John Major and Douglas Hurd, the then Foreign Secretary, pressured Margaret Thatcher to sign Britain up to the ERM in October 1990, effectively guaranteeing that the British Government would follow a economic and monetary policy that would prevent the exchange rate between the pound and other member currenices from fluctuating by more than 6%. The pound entered the mechanism at 2.95 Deutschmarks to the pound, thus if the exchange rate ever neared the bottom of its permitted range, 2.778 marks, the government would be obliged to intervene.
From the beginning of the 1990s, high German interest rates, set by the Bundesbank to avoid inflationary effects related to German re-unification, caused significant stress across the whole of the ERM. Issues of national prestige and the commitment to a doctrine that the fixing of exchange rates within the ERM was a pathway to a single European currency, inhibited the adjustmentment of exchange rates. In the wake of the rejection of the Maastricht Treaty by the Danish electorate in a referendum in the spring of 1992, those ERM currencies that were trading close to the bottom of their ERM bands can under speculative attack in the foreign exchange markets by currency speculators such as George Soros.
When the French referendum on the Mastricht treaty yielded a yes vote, the attack, which had gathered force over the first fortnight of September, concentrated on the Italian lira and the pound. On the sixteenth the British government announced a rise in the base rate from 10% to 12% in order to tempt speculators to buy pounds. Despite this and a promise later the same day to raise rates again to 15%, dealers kept selling pounds. By 7pm that evening, Norman Lamont, then Chancellor, announced Britain would leave the ERM and rates would revert to 10%. Other ERM countries such as Italy whose currencies had breached their bands during the day remaining in the system with broadened bands or with adjusted central parities. Even in this relaxed form, the ERM proved vulnerable and ten months later the rules were relaxed further to the point of imposing very little constraint on the domestic monetary policies of member states.
The effect of the high German interest rates, and so the high British interest rates, had been arguably to put Britain into recession as large numbers of businesses failed and the housing market crashed.
In the months and years following Black Wednesday, the pound traded substantially below its ERM lower band. It dipped below 2.20 Deutschmarks in spring 1995. From this point however, it began a sustained recovery and has since touched a value 3.20 DM. Some commentators believe that 'Black' Wednesday has proved to be good for the British economy in the long-term - as interest rates were allowed to find their natural level. However the reputation of the Conservatives for competent handling of the economy was shattered. Many commentators believe that that event is a key reason for the party's continued relative unpopularity.
Technically any country wishing to join the single european currency would have to join an ERM-like system tagging their current currency to the euro. However given the notoriety of the system within the British public at large, many believe this will not be a prerequisite should Britain ever wish to join.