The terms Hawkish and Dovish refer to whether central banks are more likely to tighten (hawkish) or accommodate (dovish) their monetary policy.
Central bank policy makers determine whether to extend or decrease interest rates, which have significant impact on the forex market. Policy makers increase interest rates to stop an economy from overheating (to prevent inflation from going too high) and that they decrease interest rates to stimulate an economy (to prevent deflation and stimulate GDP growth).
Hawkish and dovish policies affect currency rates through a mechanism central bankers wish to call forward guidance. This is policy makers trying to be as transparent as possible in their communications to the market about where monetary policy could also be heading.
The term hawkish is used to describe contractionary monetary policy. Central bankers are often said to be hawkish if they mention tightening monetary policy by increasing interest rates or reducing the central bank’s record. A monetary policy stance is claimed to be hawkish if it forecasts future rate of interest increases. Central bankers also can be said to be hawkish once they are positive about the economic process outlook and expect inflation to extend .
Currencies tend to move the most when central bankers shift tones from dovish to hawkish or vice versa. For example, if a central banker was recently dovish, stating that the economy still requires stimulus then , during a later speech, stated that they need seen inflation pressures rising and strong economic growth, you could see the currency appreciate against other currencies.
Some words that would be used describing a hawkish monetary policy include:
- Strong economic growth
- Inflation increasing
- Reducing the balance sheet
- Tightening of monetary policy
- Interest rate hikes
Generally, words used that indicate increasing inflation, higher interest rates and powerful economic process lean towards a more hawkish monetary policy outcome.
Dovish refers to the opposite. When central bankers are talking about reducing interest rates or increasing quantitative easing to stimulate the economy they’re said to be dovish. If central bankers are pessimistic about economic process and expect inflation to decrease or become deflation and that they signal this to the market through their projections or forward guidance, they are said to be dovish about the economy.
Some words that would be wont to describe a dovish monetary policy, include:
- Weak economic growth
- Inflation decreasing/deflation (negative inflation)
- Increasing the balance sheet
- Loosening of monetary policy
- Interest rate cuts