Hawkish and Dovish: Stances of Central Banks that Affect your Trading

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. Thats 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 policys future path, known as the forward guidance. 

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.

Bottom Line 

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. A 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.