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London — The dollar edged higher on Friday but was still set to end the year down,  reversing two years of gains, dragged down by market expectations of US Federal Reserve easing interest rates as soon as March.

The greenback crept higher on the last trading day of the year though currency moves were mostly subdued in the lull before the new year.

Since the Fed launched its aggressive rate-hike cycle in early 2022, expectations of how far US rates would rise have been driving the dollar.

But as economic data pointed to signs of US inflation cooling, investors turned their focus to how soon the Fed could begin cutting rates. These expectations strengthened after a dovish tilt at the central bank's December policy meeting.

Against a basket of currencies, the greenback was up 0.12% on Friday to 101.35, rising from a five-month trough of 100.61 hit in the previous session.

The dollar index was still on track to lose more than 2% for the month and the year.

“Markets are looking for a cut earlier in the US and are less certain that the European Central Bank (ECB) will cut as quickly, so that’s why the dollar is very soft,” said Nordea chief analyst Niels Christensen.

“We also have positive risk appetite which is another negative for the dollar. Going into 2024, the soft dollar will be a theme towards the March central bank meetings.”

A weakening dollar, meanwhile, brought relief to other currencies, with the euro last at $1.1049, hovering just below a five-month peak of $1.11395 reached on Thursday and on track to rise more than 3% for the year, its first positive year since 2020.

Sterling was on track for a gain of nearly 5%, its best performance since 2017. The British pound was last 0.2% lower on the day at $1.2711.

While policymakers at the ECB and the Bank of England (BoE) did not signal any imminent rate cuts at their policy meetings this month, traders continue to bet that a Fed pivot and the prospect of lower US rates next year will help other major central banks to follow suit.

“While it feels like the market might have moved too far too fast, the facts are that growth is nonexistent in Europe, slowing in the US, and inflation is falling globally,” said CJ Cowan, portfolio manager at Quilter Investors.

“The ECB is famously slow to change policy course so almost two cuts priced by April looks aggressive, even if it might be the right thing to do.”

Elsewhere in Europe, the Norwegian crown strengthened against the euro and the dollar on Friday after the Norwegian central bank said it would sharply reduce its purchase of foreign exchange for the sovereign wealth fund in January, cutting it to 350-million Norwegian crowns ($34.41 million) a day from 1.4-billion previously.

“It was a surprise that they announced such a low number,” said Nordea's Christensen.

“It’s good news for the Norwegian crown and supports the rally that we’ve seen in December.

Asian contrast

The yen is set to fall more than 7% in 2023, extending its losses into a third year running as the Japanese currency continues under pressure from the Bank of Japan's (BOJ) ultra-loose monetary policy stance.

While market expectations are for the BOJ to exit negative interest rates in 2024, it continues to stand by its dovish line, and has provided few clues on if and how such a scenario could play out.

“The outlook for Japan is encouraging going into 2024, with expectations of robust economic growth and improving inflation that shows signs of being sustainable,” said Aadish Kumar, international economist at T Rowe Price, citing a weak currency and accommodative policy stance as “key supports” to the view.

“Any potential moves to tighten policy via a hike in interest rates represent a key risk to the outlook. Given the BOJ will not want to risk undoing all the good work achieved to date, we believe it will remain dovish in its communication and keep policy accommodative.”

The yen was last 0.3% weaker at 141.835 a dollar.

In China, the onshore yuan was headed for a yearly loss of nearly 3%, pressured by a faltering post-Covid recovery in the world’s second-largest economy.

The yuan last stood at 7.111 a dollar, while its offshore counterpart was last at 7.1286 a dollar.


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