{"id":13245,"date":"2024-05-30T06:42:58","date_gmt":"2024-05-30T06:42:58","guid":{"rendered":"https:\/\/www.vtmarkets.com\/blog\/?p=13245"},"modified":"2024-05-30T06:42:58","modified_gmt":"2024-05-30T06:42:58","slug":"interest-rate-tug-of-war-for-central-banks-hawkish-vs-dovish","status":"publish","type":"post","link":"https:\/\/www.vtmarketsglobal.com\/en\/learn\/13245\/","title":{"rendered":"Interest rate tug-of-war for central banks: Hawkish vs dovish"},"content":{"rendered":"\n
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Interest rates, interest rates. This seems to be everything everyone with any skin in today’s financial market ever cares about. With the whole world shifting uncomfortably in their seat whenever a rate hike review is due from the Federal Reserve, this almost obsessive focus on this seemingly arbitrary number feels a little crazy for the uninitiated. <\/p>\n\n\n\n

After all, what can one little percentage point really do?<\/strong><\/p>\n\n\n\n

The concept of interest rates dates back to ancient Mesopotamia around 3,000 BC, where loans were made and interest was charged in the form of a commodity, like grain or silver. However, it was the ancient Greek philosopher Aristotle who first noted the idea of interest, albeit with skepticism, considering it unnatural. <\/p>\n\n\n\n

Fast forward to the Renaissance, when financial minds like the Italian mathematician Leonardo Fibonacci began to formalise the mathematics behind interest rates, setting the stage for modern economic theories. We still use the Fibonacci retracement as a technical analysis tool today. <\/p>\n\n\n\n

In the modern economy, interest rates are treated as the “cost” of borrowing money. They influence consumer spending, business investments, and overall economic growth. The power of interest rates lies in their ability to steer the economy. Whether it\u2019s cooling down an overheating market or stimulating a sluggish one, this little number wields immense influence.<\/p>\n\n\n\n

So how profound is the influence of interest rates on the value of any currency? We can observe how interest rates fluctuate, almost in tandem to market movement. Why then, one might wonder, is it necessary for central banks review interest rates periodically? <\/p>\n\n\n\n

And why should you as a forex trader care? <\/p>\n\n\n\n

The role of central banks in managing the economy<\/strong> <\/h2>\n\n\n\n

Central banks change interest rates primarily to manage economic stability. Changes in interest rates can determine if the economy growth of a country is sustainable, as this in turns control inflation and achieves a stable financial environment.  <\/p>\n\n\n\n

In the context of monetary policy, central banks can have varying attitudes in approaching inflation and economic growth. When describing the tone and content of speeches by central bank, two terms are commonly used: <\/p>\n\n\n\n

Being hawkish cools down the economy<\/strong><\/h2>\n\n\n\n

Hawkish policymakers prioritise keeping inflation low, often advocating for higher interest rates and tighter monetary policy. <\/p>\n\n\n\n

Their main concern is that high inflation could destabilise the economy, so they tend to act quickly and decisively to raise rates or otherwise restrict the supply of money. <\/p>\n\n\n\n

Being dovish heats up the economy<\/strong> <\/p>\n\n\n\n

Dovish policymakers are more concerned with unemployment and supporting economic growth. It is common to see lower interest rates and a looser monetary policy to stimulate borrowing and spending. <\/p>\n\n\n\n

Dovish policymakers are more willing to accept higher inflation if it means encouraging job creation and economic growth. <\/p>\n\n\n\n

When hawkish and when dovish?<\/strong> <\/h2>\n\n\n\n

To put it simply, a sensible central bank may start taking a hawkish stance when it perceives that the economy is overheating. Common signs that an economy is overheating would include rising inflation and asset price bubbles. As raising interest rates can make borrowing more expensive, a hawkish stance can potentially cool off speculative investments and reducing the risk of a market bubble. <\/p>\n\n\n\n

On the other hand, central banks tend to adopt a dovish stance when it felt the need to stimulate the economy. Recession periods, high unemployment rates and financial crises are the usual triggers. For instance, during the COVID-19 pandemic in 2020, central banks like the US Federal Reserve and the European Central Bank (ECB) slashed interest rates to near-zero levels and implementing quantitative easing to support their economies.\u00a0<\/p>\n\n\n\n

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The Federal Reserve kept its key interest rate near zero, where it's been since March 2020, but policymakers indicated the era of record-low interest rates will soon come to an end https:\/\/t.co\/C1LJbWNveO<\/a> pic.twitter.com\/iFKJIrZv6i<\/a><\/p>— Reuters (@Reuters) December 16, 2021<\/a><\/blockquote>