The terms hawkish and dovish are often used to describe the monetary policy stance of a central bank, such as the Reserve Bank of India (RBI), and its impact on the stock market. But what do they actually mean, and how do they affect the stock prices and the economy? In this article, we will explain the meaning, implications, and examples of hawkish and dovish monetary policies, and how the stock market reacts to them.
Hawkish Monetary Policy
A hawkish monetary policy is a policy that aims to control inflation and prevent the economy from overheating, by raising interest rates or taking other measures to tighten the money supply. A hawkish monetary policy is usually adopted when the central bank expects the economy to grow faster than its potential, and inflation to rise above its target.
A hawkish monetary policy can have the following effects on the stock market and the economy:
- It can reduce the demand for loans and credit, as borrowing becomes more expensive.
- It can lower the consumer spending and business investment, as people and firms have less disposable income and profits.
- It can strengthen the domestic currency, as higher interest rates attract foreign capital inflows.
- It can curb the inflationary pressures, as the aggregate demand and the cost of production decrease.
- It can slow down the economic growth, as the output and employment levels decline.
Dovish Monetary Policy
A dovish monetary policy is a policy that aims to stimulate economic growth and prevent deflation, by lowering interest rates or taking other measures to increase the money supply. A dovish monetary policy is usually adopted when the central bank expects the economy to grow slower than its potential, and inflation to fall below its target.
A dovish monetary policy can have the following effects on the stock market and the economy:
- It can increase the demand for loans and credit, as borrowing becomes cheaper.
- It can boost the consumer spending and business investment, as people and firms have more disposable income and profits.
- It can weaken the domestic currency, as lower interest rates discourage foreign capital inflows.
- It can increase the inflationary pressures, as the aggregate demand and the cost of production increase.
- It can accelerate the economic growth, as the output and employment levels rise.
Stock Market Reaction to Hawkish and Dovish Monetary Policies
Stock markets typically react differently to hawkish and dovish monetary policies. When a central bank adopts a hawkish monetary policy, by raising interest rates or taking other measures to tighten monetary policy, it can lead to a decrease in stock prices. This is because:
- Higher interest rates reduce the present value of future cash flows of the companies, making them less attractive to investorspo.
- Higher interest rates increase the cost of capital for the companies, making it harder for them to finance their operations and expansion.
- Higher interest rates lower the consumer and business confidence, leading to lower demand for goods and services, and lower earnings for the companies.
- Higher interest rates strengthen the domestic currency, making the exports less competitive and the imports more expensive, hurting the trade balance and the profitability of the companies.
When a central bank adopts a dovish monetary policy, by lowering interest rates or taking other measures to ease monetary policy, it can lead to an increase in stock prices. This is because:
- Lower interest rates increase the present value of future cash flows of the companies, making them more attractive to investors.
- Lower interest rates decrease the cost of capital for the companies, making it easier for them to finance their operations and expansion.
- Lower interest rates boost the consumer and business confidence, leading to higher demand for goods and services, and higher earnings for the companies.
- Lower interest rates weaken the domestic currency, making the exports more competitive and the imports cheaper, improving the trade balance and the profitability of the companies.
Hawkish and Dovish Monetary Policies in India
The RBI, as the central bank of India, is responsible for setting the monetary policy for the country, with the objectives of maintaining price stability, ensuring financial stability, and supporting economic growth. The RBI uses various instruments, such as the repo rate, the reverse repo rate, the cash reserve ratio, the statutory liquidity ratio, and the open market operations, to influence the money supply and the interest rates in the economy.
The RBI also communicates its monetary policy stance and outlook through its monetary policy statements, which are released after every bi-monthly meeting of the Monetary Policy Committee (MPC), which consists of six members, three from the RBI and three external experts. The MPC decides the policy rate (the repo rate) by a majority vote, and also expresses its views on the inflation and growth prospects of the economy.
The RBI's monetary policy stance can be classified as hawkish, neutral, or dovish, depending on its assessment of the inflation and growth dynamics, and its expectations of the future trajectory of these variables. The RBI's monetary policy stance can also be inferred from the tone and language of its monetary policy statements, and the voting pattern of the MPC members.
Some examples of hawkish and dovish monetary policies adopted by the RBI in recent years are:
- Hawkish: In February 2023, the RBI raised the repo rate by 25 basis points to 5.25%, and maintained the stance of 'withdrawal of accommodation', citing the persistent and broad-based inflationary pressures, and the robust recovery of the economy⁵. The MPC voted 4-2 in favor of the rate hike, with two members preferring a status quo⁵. The RBI also revised its inflation projection upwards to 6.1% for Q4 of FY23, and 5.8% for Q1 of FY24, and its growth projection downwards to 9.5% for FY23, and 7.2% for FY24⁵. The stock market reacted negatively to the hawkish monetary policy, with the Nifty 50 index falling by 0.56% on the day of the policy announcement.
- Dovish: In May 2022, the RBI kept the repo rate unchanged at 4%, and maintained the stance of 'accommodative', citing the adverse impact of the second wave of the COVID-19 pandemic on the economy, and the uncertainty over the inflation outlook. The MPC voted unanimously in favor of the status quo, and also announced several liquidity and regulatory measures to support the health and financial sectors, and the vulnerable segments of the society. The RBI also revised its inflation projection downwards to 5.1% for FY22, and its growth projection upwards to 10.5% for FY22. The stock market reacted positively to the dovish monetary policy, with the Nifty 50 index rising by 0.61% on the day of the policy announcement.
Hawkish and dovish are terms that describe the monetary policy stance of a central bank, and its impact on the stock market and the economy. A hawkish monetary policy is a policy that aims to control inflation and prevent the economy from overheating, by raising interest rates or taking other measures to tighten the money supply. A dovish monetary policy is a policy that aims to stimulate economic growth and prevent deflation, by lowering interest rates or taking other measures to increase the money supply. Stock markets typically react negatively to hawkish monetary policies, and positively to dovish monetary policies, as they affect the present value, cost of capital, confidence, and profitability of the companies. The RBI, as the central bank of India, adopts hawkish or dovish monetary policies depending on its assessment and expectations of the inflation and growth dynamics of the economy, and communicates its monetary policy stance and outlook through its monetary policy statements and the voting pattern of the MPC.