The dollar index, which measures the U.S. currency against six peers, dropped to a new five month low of 100.81

The dollar nursed steep losses on Thursday and was headed for a yearly decline following two years of strong gains as expectations of interest rate cuts from the Fed 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 peers, dropped to a new five month low of 100.81. The index dropped 0.5% on Wednesday and is on course for a 2.6% decline this year, snapping two consecutive years of strong gains.

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

Some analysts though remain unconvinced the Fed 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 ECB retained their stance of needing to keep rates higher for longer.

Markets though are still pricing in as much as 165 bps of rate cuts from the European Central Bank next year.

The European and UK economies are in a much more precarious state and we believe this will compel their respective central banks to cut interest rates both before they are fully ready and before the Fed does so, said the analysts, noting the divergence in the outlooks for the U.S. and European economies.

The euro was 0.09% higher at $1.1113, just below the five-month high of $1.1122 touched on Wednesday.

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