FXStreet (Delhi) – Research Team at Investec, explains that how monetary policy divergence will be a key theme for the global economy next year with the US looks set to see rate rises, albeit gradual ones. Key Quotes “Global Monetary policy divergence will be a key theme for the global economy next year. The US looks set to see rate rises, albeit gradual ones. Other central banks, such as the Bank of England, are likely to follow the Fed’s lead. The Eurozone however, is set to remain on a stimulus footing, as will many emerging market economies, where growth prospects are rather soft. These dynamics could see; more downward pressure on the euro, further stress in some EM economies and on their currencies, and continued weakness in commodity prices. However, we think these forces will be kept largely in check next year – we actually see the euro rising, pressure on EMs abating, commodity prices recovering a little and global growth generally on a more even keel. United States The new focus in the US monetary policy debate should shift away from ‘lift off’ towards the pace of tightening, where the Fed will proceed with caution and clear communication to avoid a 1994-type situation when the yield curve steepened sharply. Following a likely 25bp move on 16 December, we expect hikes of 75bps over 2016 to a Fed funds target range of 1.0%-1.25% by end-year. Given the shallowness of the implied market path, we expect upward pressure on Treasury yields, with the 10-year at 2.75% by end-2016. The Fed will be anticipating signs of inflation; not just owing to the removal of commodity price base effects, but also wage pressure resulting from tighter, arguably stickier labour markets. Consumers’ expenditure continues to look healthy though we will be watching for the impact of higher inflation on real measures of activity. Despite tightening monetary conditions, the fading drag from USD strength should help to support stockmarkets. Eurozone The euro has rebounded in response to what markets considered to be a relatively tame set of ECB easing measures. It is not impossible that the Euro flirts with parity with the US dollar at some stage in the near-term, from $1.08 now. However we would judge that policy divergence between the eurozone and the US is priced in and while it is impossible to rule out further ECB easing, this is not our baseline case. We note; i) there is some positive momentum in growth and credit flows; ii) the ECB balance sheet is set to reach €3.7trn on current ECB plans by March 2017; iii) at current trends the unemployment rate would fall to its pre-crisis average of 9.0% in just over two years’ time and; iv) on our PPP estimates the euro is already 15% undervalued, which may stiffen its resistance to further weakness. We have not changed our call that the EUR will recover against the US dollar through most of 2016 and continue to target $1.15 end-year. United Kingdom For the UK we still see solid growth in 2016 and a gradual upward trend in the Bank rate starting mid-year. The past couple of years suggest that were the US dollar to surge on the back of a Fed hike, sterling’s trade weighted index would be likely to rise due to the dynamics between the USD, EUR and GBP and the EUR’s large weight in the basket. But our big picture currency call over 2016 is that the EUR will recover and our end-year sterling forecasts are 74p for EUR:GBP and $1.55 for GBP:USD.” For more information, read our latest forex news.