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Dovish Explained

Beginner

The term “dovish” is applied to any person or organisation that approaches a situation with a passive response. In financial markets, the term dovish tends to be associated with central banks and their outlook for monetary policy.

A dovish central bank (or central banker) uses easy monetary policy in response to a low or negative growth economic outlook. If growth or inflation is too low or negative, this will encourage the easing of monetary policy conditions. This will include the cutting of interest rates (conventional policy response) in addition to possible asset purchases (unconventional monetary policy response).

Once the easy monetary policy measures take effect, a dovish central bank will be slow to normalise monetary conditions. They are cautious for fear of choking off the economic recovery too quickly before it can be self-sustaining. Monetary policy doves are therefore happy to tolerate higher levels of inflation to be more sure that the economic recovery can be confirmed.

The opposite of a dovish monetary policy is a “hawkish” approach. A hawkish response is considered to be more aggressive, less tolerant of inflation and quick to raise interest rates.

N.B. The term dovish can also be associated with geopolitics. If a politician was “dovish on international relations”, they favour dialogue and negotiation over an aggressive military response to resolving foreign policy conflicts.

The impact of “dovish” monetary policy 

If a central bank is dovish on monetary policy, there will tend to be a fairly standard impact across a country’s asset classes. This involves market reaction to cutting interest rates (or even the threat of cutting interest rates), engaging asset purchases, or having monetary policy too loose for too long:

  • Bond yields – yields will tend to fall (on rate cuts or asset purchases) or remain relatively lower for longer (if the central bank is not tightening monetary policy as fast as other central banks).
  • Currency – all things remaining equal, a more dovish monetary policy will be negative for a currency. With lower interest rates, international hot money flows out of a currency where the yield is less attractive.
  • Equities – A dovish monetary policy environment tends to be more positive for equities. If the corporate borrowing rates are lower then it is less expensive for companies to invest and expand their business. “Growth” stocks (low or zero yielding) tend to outperform “value” stocks (cheaper valuation, higher yield).

Editor

Richard is an independent market analyst with over 20 years of experience working for brokers in London. Most recently he has worked with Hantec Markets and Infinox, focusing on trading education, ana... Continued

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