The term dove is used to describe an accommodative monetary policy aimed at revitalizing the economy of a country, the dove being full of good intentions. Its objective is to boost GDP growth and inflation during an economic slowdown. A dove will generally encourage a policy of interest rate reduction, and even use unconventional tools such as massive injections of liquidity through asset buybacks. The low interest rates reduce the cost of borrowing and allow for the injection of additional liquidity in the system. As such, economic actors are encouraged to borrow, to consume and to invest, which should in theory, boost the economy of a country.
Currently, the monetary policies of the Fed, the BoJ, the BoE and the ECB are clearly dovish.
On the other side of the spectrum, the term hawk is synonymous of a more restrictive monetary policy, as the hawk uses force to resolve a conflict. In the event of high inflation and overheating in the economy, central bankers may proceed to a monetary tightening, through raising interest rates or even stopping asset buybacks, in order to reduce liquidity. By raising interest rates, access to credit is reduced, economic actors are more inclined to save, rather than borrow. This strategy makes it possible to control the money supply in circulation, and therefore inflation.
So, it appears that monetary policies from central banks have an impact on the forex market.
A hawkish monetary policy a rise in interest rates has a positive impact on the currency involved. Indeed, raising rates, as we mentioned earlier, reduces inflation. Knowing that inflation reduces the value of a currency, raising rates will allow the currency to appreciate. This will in turn attract foreign investors, as the remuneration of their assets denominated in this currency will increase.
A dovish monetary policy lowering interest rates has, on the contrary, a negative impact on the currency involved. Lowering rates will stimulate inflation, and the currency will will then depreciate against its counterparts, thus attracting less foreign investors.