ECB Code Words for Dummies

The Wall Street Journal's finance blog "The Source" analyzes European Central Bank chief Jean-Claude Trichet's use yesterday of the phrase "strong vigilance" in reference to the prospect of forthcoming interest rate raises, and what this means in numerical terms for market watchers. The Financial Times alternatively terms the code a "traffic light system" that indicates rate rises with a certain reliability.

Particularly interesting is the article's chart of ECB verbal expressions and their corresponding interest rate change metrics, which should demystify for all of us non-economists (myself included) some of the opaque language used by economists and finance folks on each side of the Pond. 

By the FT's count, the ECB has invoked the words "strong vigilance" and then raised rates seven out of nine times since 2005. 

The WSJ article surmised that Trichet's most recent use of the expression "strong vigilance" can be translated in layman's terms to, "we are worried about inflation and are leaning toward raising interest rates." 

Trichet's hawkish if nuanced rhetoric is widely perceived as a way of projecting a confident public front for the ECB in the face of grave concerns over the EU's economic recovery strategy on the eurozone's sovereign debt and the global financial crises.

If the past six years are anything to go by, turns of phrase such as "vigilance," "monitor closely" and in particular "strong vigilance" all preceded actual interest rate shifts orchestrated by the ECB. As the piece puts it,

“During the last tightening cycle, ‘strong vigilance’ was used one month prior to all policy moves (except for the one in March 2006, when only ‘vigilance’ was used). In addition, some form of ‘monitor closely’ or ‘monitor very closely’ was used in other months to signal that the rate normalization was not yet complete. Such code words could be used again this time."

Sources have varied widely on whether Trichet's words should be considered worrisome. Reuters says that the Frankfurt-based bank "stunned markets by indicating it could raise interest rates as soon as next month." In contrast, Seeking Alpha puts the odds of a rate hike at "above zero, [but] not much higher."