Hawkish and dovish are common terms used specifically in financial markets to describe the central bank monetary policy stance. Policymakers are often portrayed as either hawkish or dovish as well according to their individual perception of monetary policy guidance. Both terms refer to different points of view on the policy path and its direct influence on the economy.
Hawks are seen to be more concerned about keeping inflation under control, they advocate higher interest rates to restrict money supply in the economy. Doves, on the other hand, are more focused on overall economic growth and jobs creation. That’s why they support lower interest rates to maintain the money supply.
Eventually, the value of studying the market response to the release of economic reports or central bank activities can be reflected in the efficiency of the fundamental analysis. Forex traders are always trying to reach higher accuracy with their expectations of the market.
What is the Role of Central Banks?
A central bank is a financial institution that sets the monetary system for a nation. Central banks are given privileged authority to issue currency, function as the bank of the government, manage exchange reserves, regulate the credit system, oversee commercial banks and act as a lender of last resort. Central banks have a defined range of responsibilities that includes overseeing monetary policy and implementing specific tools to achieve main mandates such as currency stability, steady inflation, and full employment.
Some central banks have a single mandate which is price stability, such as the European Central Bank. Others have dual policy mandates; price stability and employment, like the Federal Reserve and Reserve Bank of New Zealand.
Central banks determine whether to raise or cut interest rates to achieve their policy mandates which are commonly inflation stability and job growth. Higher interest rates are intended to prevent economic growth and inflation from overheating, while lower rates are adapted to stimulate the economy.
Hawkish and dovish stances affect the monetary policy’s future path, known as the forward guidance.
What is Forward Guidance?
Forward guidance is a communication tool used by central banks to convey the economic situation and the potential path of monetary policy. It is a very effective approach to influence market expectations by revealing future monetary policy intentions.
Despite the ongoing controversy about its effectiveness, forward guidance has increasingly become a key tool for modern central banking. The Federal Reserve was one of the earliest major central banks to use forward guidance in its policy statements since the early 2000s.
However, the role of forward guidance became more significant in the wake of the financial crisis back in 2008. While banks had no other option but to be dovish as interest rates at their historical lows, it was important to expand monetary policy influence on the market through expectations of long-term interest rates.
Hawkish and Dovish Explained
Hawkish is seen as a positive tone, where a central bank considers tightening policy and hikes interest rates in wake of a better economic outlook. It is used normally to describe a contractionary monetary policy. Policymakers are described as hawkish when they talk about or support policy tightening by increasing interest rates or reducing stimulus. A monetary policy is seen as hawkish when a rate hike is forecasted, and when a central bank adopts a positive tone about the economic outlook.
Phrases used in a hawkish monetary statement include strong economic growth, reducing the balance sheet, high inflation, tightening of monetary policy, and interest rate hikes.
Dovish is the total opposite. It is seen as a negative tone, as the central bank considers taking expansionary measures and cutting interest rates to fight economic downturns. A dovish statement is used when a central bank obtains a cloudy economic forecast regarding growth and inflation. Terms used in a dovish statement may include weak economic growth, increasing balance sheet, low inflation, stimulus, and interest rate cut.
A clear shift in any central bank’s stance from hawkish to dovish, or vice versa, tends to influence the currency directly. For example, the currency appreciates against other currencies if the central bank conveys a positive outlook after stating that the economy needs stimulus. Conversely when a bank refers that the economy is slowing down and inflation is decreasing, hinting at a possible rate cut and applying stimulatory measures. That’s how hawkish and dovish policy views affect the value of currency differently. Read more on currency appreciation and depreciation.
Hawkish and Dovish Stances
|Objective||Contain inflation & growth||Stimulate inflation & growth|
Types of Monetary Policy
Monetary policies are divided into two main categories; expansionary monetary policies and contractionary monetary policies. Both involve controlling the level of the money supply in a country to maintain steady and sustainable economic growth.
Expansionary monetary policy is simply aimed to increase the supply of money, while contractionary monetary policy works on decreasing currency supply to curb demand.
A neutral monetary policy intends to neither create growth nor fight inflation.
To achieve their policy mandates, central banks use monetary tools, mainly the interest rates, to achieve stable inflation, growth, and money supply in the economy.
The Role of Interest Rates
Central Banks tend to raise interest rates to curb high inflation and an overheating economy. This is because high-interest rates mean people and businesses will borrow and spend less. These policies aim to prevent the economy from growing too fast which can create economic bubbles.
On the contrary, when an economy is shrinking, interest rates are lowered as the central bank wants people to borrow and spend more. Lower interest rates encourage more people to borrow and spend, therefore stimulating the economy. When the central bank considers lowering interest rates, it means that the economy is not doing well which leads traders to sell that currency. And when lowering the interest rate isn’t efficient enough to revive the economy, the central bank may start quantitative easing.
In the forex market, currencies benefit from higher interest rates against lower-yielding currencies. As interest rates go up, interest in the currency follows. Same as any market, investors look for higher returns and the best economy to invest their money in. Here the big effect of interest rate differentials steps in. The higher a country’s interest rate is, the more likely its currency will get stronger. In contrast to currencies of lower interest rates, they are more likely to weaken in the longer term.
A dovish monetary policy stance aims for stimulating economic growth and employment, which is typically by cutting interest rates and sometimes signaling the possibility of further reductions. On the other hand, being hawkish means tightening policy through increasing the interest rate and/or reducing or exiting any monetary expansion. Market investors usually watch for hawkish and dovish signals from central banks and policymakers in order to anticipate future market direction.
Hawkish and dovish stances have a direct impact on market sentiment. Hawkish stance is often seen as a bullish factor that helps the currency to appreciate, while dovish is bearish as it implies lower rates and weak economic activity. Know more about Bullish and Bearish Markets.
Trading News and Analysis
In the world of forex trading, it is essential to frequently review the market news and to conduct analysis. While traders tend to avoid the complexity of fundamental analysis and rely on forex signals and trend analysis, understanding the financial market provides extensive skills for traders and more accurate prediction. Our market analysis team of technical and fundamental analysts provides weekly forex analysis and market outlook about the major currency pairs as well as top economic events and releases. Follow our forex news and get access to leading news feeds.
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