Events in the international economy, where destabilising forces were at play during the 1970s, provided context for the crisis. The oil crisis of 1973 generated inflationary forces, increasing energy and commodity prices. At the same time, the world economy was in recession. The Bretton Woods international monetary system was formally ended in 1973, and currencies were now free to float independently.
The international recession was mirrored in Britain's economy. It was a period of 'stagflation', in which recession combined with inflation. Retail price inflation reached 27 per cent per year in August 1976. Inflationary wage increases were accompanied by a rise in unemployment, which reached one million in early 1976. High unemployment required increased government expenditure and borrowing.
Harold Wilson's Labour Party was elected to government in February 1974 without an overall majority. The Labour election campaign was conditioned by the perceived need to co-operate with the trade unions, and was based upon commitment to the 'social contract' and public spending. An international loss of confidence in sterling soon occurred due to the combination of recession, instability, and commitment to social expenditure. This led to the devaluation of sterling.
Labour gained a tiny majority in a further election in October 1974. In his budget of April 1975, the Chancellor, Denis Healey, attempted to decrease the deficit by increasing the basic rate of taxation to 35 per cent, reducing the rate of growth of public expenditure and restricting the supply of money. Nevertheless, the budget provided for a record public borrowing requirement of nine billion pounds. Although it marked a shift away from the social contract towards the control of inflation, Healey's budget was viewed critically in the financial sector. Many believed the economy was out of control, and the Wall Street Journal advised against investment in sterling.
By mid-1975 an exchange crisis appeared to be an immediate threat and Cabinet members considered counter-inflationary measures, including limiting wage increases through negotiation with the Unions. In December 1975 the Cabinet agreed to Healey's proposals for limiting public expenditure, which were incorporated into the Public Expenditure White Paper of February 1976.