Me and the Bank of England

One of the interesting buttons on my desk was marked BofE. This was a direct line through to the dealing room of the Bank of England. In my early days, this wasn’t really used so I got used to it being there but of no real meaning. Then, one day, I got into work before John Botevyle to find the red light to them was lit. This meant that they had called and no one had answered. I rang them back to be greeted with a complaint that the room wasn’t manned when they wanted us. I explained that it was only 8.50 and we didn’t open until 9am, which didn’t impress the chap on the other end at all. He told me that, as we weren’t there when he wanted us, he had done a deal on our behalf. It turned out that the BofE had bought five million pounds from Swiss Bank Corporation (SBC) in Zurich but, as was usual at that time, she (the BofE was always referred to in the feminine – this coming from here sobriquet of ‘The Old Lady of Threadneedle Street’, or just ‘The Old Lady’) was putting the deal through us to avoid her name going on a deal in another jurisdiction. I accepted this – what else could I do – and processed the deal.

I explained to John and his comment was that they hadn’t done this for some time so the pressure on the pound must be building up. “Expect more of these” was his comment.  It seems that the pound was slipping below the bank’s bottom limit of 2.7820 and she had to intervene. Putting it through us solved her problem. Over the coming weeks, this became a regular operation.  One day, I took a phone call at around 9.10 to find that I was talking to SBC Zurich directly. He told me that he had done a deal with “our mutual friend” for three million pounds and that we were to process it. It shows that even the Swiss banks took the anonymity of the BofE seriously such that he wouldn’t even speak the name over the telephone. Quite why the BofE didn’t tell us herself I never understood but it only happened on one occasion.

From then on things hotted up and we found ourselves fully engaged in the BofE support operations. It was very exciting to read in the paper that the BofE had done x millions in the market on a day only for me to know that we had done more than the stated amount along with two other banks being involved. As the BofE never disclosed or confirmed her involvement, it was always the Evening Standard’s guess that got published. We, once again, come back to the inflation multiplier to get a real idea of the amounts involved in this operation. I know that on some days, we traded fifty million pounds on the bank’s behalf. In today’s money this represents around £790,000,000 or £2,500,000,000 in salary adjusted pounds – yes, two and a half billion! On the one day in the month that the trade figures were announced, thing got even hotter.

The balance of trade flows was a closely watched statistic at that time and the UK was consistently importing much more than it exported. It still does but, in those days, the financial standing of the UK was precarious and we relied totally on our ability to balance our books to maintain our foreign currency reserves. Nowadays, we have a similar trade problem but the UK has a great standing as a secure haven for funds and thus inward investment keeps this in some sort of kilter. During the depths of the crisis, the country was fast running out of money and had to negotiate a range of currency swaps whereby we loaned Sterling to, say, the Swiss central bank and they lent us Swiss Francs. This was fine provided that the BofE could maintain the value of the pound but if there should be a devaluation, then the country would lose a lot on the exchange rate when unwinding the swap.

This came to a head one glorious day when the BofE decided that there weren’t enough Dollars in the kitty to continue supporting the market. They came up with, what they saw, as a brilliant idea. Why not support the market by selling dollars for delivery in three months time. Normally, the liquidity in the money markets was much greater than the exchange market as it responded to investment, whereby the exchange market was all about day-to-day cash requirements. Because of the difference between dollar and sterling interest rates, buying pounds for future delivery was different from the spot rate. With interest rates as they stood at that time, the difference between the current spot price and the three months forward exchange rate was around one a one half cents. This meant that, if the BofE wanted to support the pound at 2.7820, then they would have to offer to buy pounds in 90 days at 2.7666. This was tantamount to a devaluation in all but name but only around 2 1/2 %. I am not sure just how much of this the government understood. The Chancellor of the Exchequer was Jim Callaghan, who was not a banker or a finance man, so relied on the BofE to advise him. The truth was that, should the pound stay at its current value then the BofE would make a profit when the time came to settle these trades. However, should the pound devalue by any more than 2 ½ % then there would be a nominal loss. It seemed likely, if the pound did ever devalue that it would be by around 15% or so which would result in the bank and therefore the country having a large exchange loss.

Well, it started at around 10 am. I took a call that told me to go into the market and buy up to 50 million pounds at the current three months outright price. After shaking my head in disbelief, I told John what we had been asked to do. We went to our main broker for Cable (USD/GBP), which was M.W. Marshall, and gave them the order to buy up to 5 million. We didn’t was to show our hand too quickly. We shortly received that amount. What was interesting was that the name on the trade was N.M. Rothschild. Now NMR (as they were known) was not a spot market trader except for their own customer requirements so this was unusual. What was happening, of course, is that the broker was getting a swap price from NMR; i.e. NMR was buying the pounds on the spot date and selling them back at a fixed price on the three months date. That left the broker to find a spot counterpart. Let’s say that this was SBC London. So SBC London sold the spot pounds to NMR. Then NMR sold the forward pounds to us, thus completing the deal and achieving the BofE’s requirement that their pounds only went out in the future. Fifty million pounds later, we advised the BofE that we were done. I assume that they had other clearing banks doing the same as us.

Shortly after we had completed, I had to go to another department for something and, on getting in the lift, found that the Head Office General Manager; i.e. the overall boss of all the foreign activity in the bank – was also in that lift. “Hello Pennington (no Christian names in those days). What’s happening in the markets?” I was particularly proud that, as a mere 22 year old, I was on talking terms to the big boss. “Oh, we are supporting the pound by buying three months outright.” “That’s surprising. Whom are we dealing with?” “Oh, N.M. Rothschild on every trade.” Said I without too much thought. “How much have we done?” he asked. “Around 50 million.” Says I. “Hmmm. What is our trading limit for Rothschild?” he asked. I had to admit that it was only 5 million but explained that it would not have been possible to turn down any trade as the market was too volatile and if we had stopped then we would get it thick in the ear from the Old Lady. Fortunately, he realised that firstly, it was John Botevyle’s decision, not mine, and that I was probably right. On telling John of the exchange, we both felt that, although we had broken the bank’s rules, we couldn’t have done anything else. Oh what fun we had!

I remember one other incident with the BofE. One day, they told me to do ‘a bit’. After 20 million, I reported back to be blasted out of my chair because they thought that ‘a bit’ was a lot less than that amount. Two hours later, they told me, again, to ‘do a bit’. I reported back on 5 million and got blasted for not doing enough. The only answer possible in all of this to the chief dealer of the BofE was ‘Yes sir.’!


A worked example of a three months forward price.

Exchange Rate GBP USD
2.7820 6.9 4.55
Spot £1,000,000.00 $2,782,000.00
Interest 90 days £17,013.70 $31,645.25
2.7666 £1,017,013.70 $2,813,645.25
Forward Swap 0.0154


So, in the above example, you could obtain 6.9% interest on the pounds but only 4.55% on the USD. For someone to take your dollars and to give you pounds, they would lose 1.35% on the deal. Therefore, the exchange rate on the forward end had to vary from the spot by that amount for anyone to do the exchange deal. The outright exchange price is calculated by dividing the sterling amount into the dollar amount. The spot rate is subtracted from this rate to give the “swap” price of -154 premium as it would be quoted in the markets. Clear? I thought not!

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