By Ankur Banerjee
       SINGAPORE, Dec 28 (Reuters) - 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.
    Some analysts though remain unconvinced the U.S. central
bank would be so aggressive.
    "We still believe that a March policy change toward easing
is much too early and there is quite a bit of potential for a
dollar rally if and when such action does not materialize,"
Monex USA analysts said in a note.
    While the Fed took an unexpectedly dovish stance in its
December meeting, opening the door to rate cuts next year, other
major central banks, including European Central Bank retained
their stance of needing to keep rates higher for longer. 
    Markets though are still pricing in as much as 165 basis
points of rate cuts from the ECB next year.
    "The European and UK economies are in a much more precarious
state and we believe this will force their respective central
banks to cut interest rates both before they are fully ready and
before the Fed does so," said the Monex USA analysts, noting the
divergence in the outlooks for the U.S. and European economies. 
    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.
    The central bank, however, stuck to its policy earlier this
month and Governor Kazuo Ueda on Wednesday said he was in no
rush to unwind ultra-loose monetary policy as the risk of
inflation running well above 2% and accelerating was small.
    For the year, yen is down 7% against the dollar.
    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%.

    ========================================================
    Currency bid prices at 0122 GMT
 Description      RIC         Last           U.S. Close  Pct Change     YTD Pct     High Bid    Low Bid
                                              Previous                   Change                 
                                              Session                                           
 Euro/Dollar                  $1.1115        $1.1105     +0.10%         +3.75%      +1.1118     +1.1101
 Dollar/Yen                   141.5200       141.7450    -0.16%         +7.84%      +141.6550   +141.3000
 Euro/Yen                                                                                     
 Dollar/Swiss                 0.8415         0.8432      -0.15%         -8.95%      +0.8429     +0.8414
 Sterling/Dollar              1.2810         1.2799      +0.10%         +5.94%      +1.2812     +1.2797
 Dollar/Canadian              1.3198         1.3210      -0.08%         -2.58%      +1.3210     +1.3197
 Aussie/Dollar                0.6862         0.6848      +0.23%         +0.68%      +0.6865     +0.6842
 NZ                           0.6360         0.6341      +0.31%         +0.17%      +0.6362     +0.6337
 Dollar/Dollar                                                                                  
                                                                                                
    
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 (Reporting by Ankur Banerjee in Singapore. Editing by Sam
Holmes)