The dollar nursed steep losses on Thursday and was headed for a yearly decline after two years of strong gains as expectations of interest rate cuts from the Federal Reserve next year grip markets.

With the year coming to a close, thin liquidity and limited moves are expected until the New Year.

The dollar index, which measures the U.S. currency against six rivals, fell to a fresh five month low of 100.81. The index fell 0.5% on Wednesday and is on course for a 2.6% decline this year, snapping two straight years of strong gains.

Investor focus remains on the timing of the interest rate cuts from the Fed, with markets pricing in a 89% chance of a cut in March 2024, according to CME FedWatch tool. Futures imply as much as 158 basis points of Fed easing next year.

The euro was up 0.09% at $1.1113, couched just below the five-month peak of $1.1122 hit on Wednesday. The single currency headed for a yearly gain of 3.7%, its strongest performance since 2020.

Sterling was last at $1.2813, its highest since Aug. 10. The pound is headed for a 6% gain in the year, its strongest performance since 2017.

Investors expect that the Bank of England will not be able to cut rates as much as the Fed and ECB, given inflation is running higher in the UK.

That has widened the gap between British bond yields and those in the U.S. and Europe, making them look more attractive and boosting the pound.

Meanwhile, the Japanese yen strengthened 0.23% to 141.50 per dollar, inching closer to a five-month peak of 140.95 it touched earlier this month.

The Asian currency is up 4% against the dollar in December, heading for its second straight month of gains on increased expectations that the Bank of Japan may soon move away from its ultra-loose monetary policy.

Rate cut bets have also boosted riskier currencies, with the Australian dollar and the New Zealand dollar perched at fresh five-month peaks. The Aussie was last up 0.26% at $0.6865, while the kiwi was at $0.6360, up 0.3%.

Source: Reuters