Jargon Buster: dovish, neutral and hawkish stances in RBI monetary policy

You have probably heard a financial news presenter say something along the lines of “The central bank governor came out slightly hawkish today after bouts of strong economic data”. The terms Hawkish and Dovish refer to whether central banks are more likely to tighten (hawkish) or accommodate (dovish) their monetary policy.

By guiding the markets with policy stances, the rate-setting panel demonstrates its broader policy approach. Let's try to figure out what those terms mean and what each of these stances means.‘

’Accommodative (dovish)’

An accommodative stance means the central bank is prepared to expand the money supply to boost economic growth. The central bank, during an accommodative policy period, is willing to cut the interest rates. A rate hike is ruled out. The Reserve Bank of India (RBI) has been on an accommodative stance for the last two years to support the economy during the COVID-19 crisis. The central bank typically adopts an accommodative policy when growth needs policy support and inflation is not the immediate concern.

When central bankers are talking about reducing interest rates or increasing quantitative easing to stimulate the economy they are said to be dovish. If central bankers are pessimistic about economic growth and expect inflation to decrease or become deflation and they signal this to the market through their projections or forward guidance, they are said to be dovish about the economy.

Some words that could be used 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

‘Neutral’

A ‘neutral stance’ suggests that the central bank can either cut rate or increase rate. This stance is typically adopted when the policy priority is equal on both inflation and growth. During neutral policy, the central bank doesn’t commit to hike rates or cut. The interest rate can move to either sides depending on incoming data. The guidance indicates that the market can expect a rate action on either way at any point.

‘Tighten (hawkish)’

A hawkish stance indicates that the central bank’s top priority is to keep the inflation low. During such a phase, the central bank is willing to hike interest rates to curb money supply and thus reduce the demand. A hawkish policy also indicates tight monetary policy. A rate cut is nearly certain during such a period. When the central bank increases rates or 'tighten' the monetary policy, banks too increase their rate of interest on loans to end borrowers which, in turn, curbs demand in the financial system.

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 and then, in a later speech, stated that they have seen inflation pressures rising and strong economic growth, you could see the currency appreciate against other currencies. Some words that could 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 strong economic growth lean towards a more hawkish monetary policy outcome.

‘Calibrated tightening’

Yet another term, the central bank uses often is calibrated tightening. Calibrated tightening means during the current rate cycle, a cut in the repo rate is off the table. But, the rate hike will happen in a calibrated manner. This means the central bank may not go for a rate increase in every policy meeting but the overall policy stance is tilted towards a rate hike. This can happen outside the policy meetings as well if the situation warrants.

’Quantitative Easing’

It is a form of monetary policy used by central banks as a method of quickly increasing the domestic money supply and spurring economic activity. Quantitative easing usually involves a country's central bank purchasing longer-term government bonds, as well as other types of assets, such as mortgage-backed securities (MBS). In response to the economic shutdown caused by the COVID-19 pandemic, on March 15, 2020, the U.S. Federal Reserve announced a quantitative easing plan of over $700 billion. Then, on June 10, 2020, after a brief tapering effort, the Fed extended its program, committing to buy at least $80 billion a month in Treasuries and $40 billion in mortgage-backed securities, until further notice.

Hawkish and dovish policies affect currency rates through a mechanism central bankers like 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 may be heading.

If you want to know how Monetary Policy Affects FX Trading ? Then please consider checking out this article.