Not created equal

The extent to which the Iron Cross differs from the British pound/U.S. dollar rate (GBP/USD) also can be shown in terms of the long-term interest rate history. Here, the seminal event was neither the Maastricht Treaty nor the creation of the euro, but rather the 1985 Plaza Accord, a concerted agreement to weaken the USD in the vain hope such a move would correct the persistent U.S. current account balance. Two decades after the fact, to say this agreement failed in this regard is a gross understatement. It did, however, succeed in creating violent moves in U.S. short-term interest rates and helped precipitate the 1987 stock market crash, so in fairness it did achieve some results.

After the Plaza Accord, the GBP rose sharply against the USD, but there was no appreciable decline in relative short-term interest-rate volatility as measured by the spread between the UK base lending rate and the U.S. federal funds rate. That volatility declined only after September 1992, when this interest-rate spread began leading changes in the GBP-USD exchange rate by six months on average.

The greater volatility of the UK base lending rate has led many to erroneously conclude the Bank of England is some sort of stalking horse for the Federal Reserve, just as the Bank of Belgium often was for the Bundesbank prior to the introduction of the EUR. Only twice after the Plaza Accord, in June 1996 and again in February 2004, did a BOE rate hike precede one by the Federal Reserve. The opposite is not quite as strong; a prolonged move in one direction by the Federal Reserve often leads a similar directional move by the BOE. This has yet to happen after the Federal Reserve’s long string of rate hikes in 2004-2006.