The school has the corporate right, and responsibility, to see that inappropriate use of the system does not occur, but this is an extremely provocational way of doing it. There are much easier and cheaper ways to get the same result. The keystroke monitoring software will require a lot of someone's time to check and is very invasive and denies any privacy.
The aims of the system should be to stop access to unapproved inappropriate web sites and abusive language, right.
Most mail client and web browsers now have built in controls to eliminate inappropriate language.
There are dozens of applications that can be placed on the gateway server that monitors website access and can easily be set to bar access to black listed websites. So when you see someone access one that is not appropriate you add it to the black list and bar future access.
There should be no need for staff or students to access chat or IM programs outside the school, so just block those ports at the gateway. This allows the use of chat and IM within the organisation but blocks exterior usage or access. The unaproved web based services like this can be put on the web site black list.
Even the students have a right to say what they like in their personal diaries or to use what passwords they want. A very common soft way of releasing anger re systems is to use abusive passwords, and that is really their business and no one elses.
The keystroke business can also lead to other problems. I once worked in a place where a fellow could not not send emails to a close friend in asia due to excessive monitoring and managing software - it eliminated the emails as abusive as the asian gentleman's email address was ifuk@.... his name was Ian Fuk (and old and not uncommon asian name.) The system must have some way to allow sensibility of use. Excessive and confrontational controls like you mention are just a clear statement that they do NOT want the students or staff using the school system at all.
I would not be surprised to see the students rally and refuse to utilise the school IT system, and then where will the school be. The students won't get as good grades as they should and that will adversely reflect upon the school and the teaching staff. Also the low usage rate of the system would ague against any future upgrades or expansion of services and staff - it would argue for reductions of them.