“Strong vigilance”.
“Heightened alertness”.
If you hear either of these phrases at Thursday’s ECB press conference (which starts at 1.30pm London time) then brace yourself for an early interest rate rise.
The reality is you won’t — the earliest this language might appear is July, reckons Nick Matthews, senior European economist at Royal Bank of Scotland.
But given the rise in eurozone inflation and the hawkish noises from President Jean-Claude Trichet, ECB language is back in focus.
As such, it’s worth remembering how the ECB communicated with the market in tightening cycle that began in December 2005, says Matthews.
This was done via code words, in what basically amounted to a traffic light system:
As you can see, when the ECB governing council mentioned “strong vigilance” and later “heightened alertness” a rate rise was never far away. Says Matthews:
In November 2005 the ECB repeated its “strong vigilance” message, crystallised the upside risks to price stability and highlighted “buoyant monetary and credit growth”. This message of “strong vigilance” was the pre-cursor to the ECB rate hike and start of the tightening cycle in December 2005.
Over following months the ECB developed its “traffic light” coded wording system. In December 2005 (ie. a rate hike month) the language shifted to the Governing Council saying it would continue to “monitor closely” all developments with respect to risks to price stability, while the next month the language was hardened to “monitor very closely”, before the alert was raised to “exercise vigilance” in February, the month before the next rate hike in March 2006. In March 2006 the language reverted back to “monitor closely”.
This pattern was repeated from March 2006 onwards, with “monitor closely” used in the month of a rate hike to indicate the ECB had returned to something resembling a holding position, while “monitor very closely” was a statement of intent that it could hike in two months time. The use of “strong vigilance” (the stronger form of “exercise vigilance” used in February 2006) was the signal the ECB were very likely to raise rates the following month.
The ECB’s current language is “monitor very closely which has, in the past, been consistent with the central bank being couple of months away from a hike:
The traffic light system became so well established and recognised that the ECB were able to effectively communicate a step-up in the pace of its tightening in the summer months of 2006. The ECB went straight from “monitor closely” in June 2006 to “strong vigilance” in July 2006 as a signal it would raise rates in August 2006. At the time of the August 2006 rate hike, the ECB then went straight back to “monitor very closely” (rather than “monitor closely”) as a signal that rates would continue to be increased every two months. Rate hikes were duly delivered in October 2006 and December 2006. However, the pace of tightening went back to one hike a quarter in H1 2007, signalled by the ECB repeating “monitor very closely” in January 2007
Now few economists expect that wording to change today.
But markets should be on alert over the coming months, says Matthews.
Any phrase resembling “strong vigilance” or the more recent incarnation of “heightened alertness” if the ECB were seriously signalling an early rate hike.
You have been warned.
Related links:
A conspicuously absent ECB – FT Alphaville
ECB halts emergency purchases of bonds - FT
What the ECB’s bond-buying has lost - FT Alphaville