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Sterling slips as boost from new China COVID rules fades

By Amanda Cooper

LONDON, Dec 5 (Reuters) - The pound slid on Monday, as an initial jolt of investor enthusiasm over signs of possible loosening in COVID restrictions in China faded, and sterling still held within sight of five-month highs against the dollar.

The dollar started out the day on the backfoot, after China prepared to unveil another round of measures to ease restrictions on activity, which investors took as a sign of a potential shift in the government's tough zero-COVID policy.

By late morning in London, much of the risk rally that took sterling to a session high of $1.2345 had run out of steam, leaving the pound down 0.3% at $1.2259. It fell 0.4% against the euro to 86.13 pence.

Sterling rose by 5.2% against the dollar in November, its strongest one-month performance since 2020, but it could struggle to make much more headway, given an increasingly gloomy economic picture in Britain and a tricky political landscape.

"For sterling, it could be a case of 'too much, too soon'," Rabobank head of currency strategy Jane Foley said on the pound's gains last month.

Much of the dollar's recent weakness has also been driven by expectations the Federal Reserve will deliver a rate rise of just 50 basis points this month, having raised rates by 75 basis points at each of its last four meetings.

Data on Friday showed the U.S. economy created more jobs than expected last month, making it harder for the Fed to justify slowing the pace of monetary tightening, when inflation is still running at almost 8%.

Meanwhile, UK data on Monday showed Britain's services sector shrank slightly for a second month in November, as cost-of-living pressures and uncertainty about the economic outlook squeezed demand, a survey showed on Monday.

Money managers are still bearish towards sterling, according to weekly data from the Commodity Futures Trading Commission (CFTC). They still hold a net short position - meaning they're negative generally. But that position is also more than 50% smaller than the depths seen earlier this year, which could leave less room for big rallies, especially with the Bank of England meeting next week.

"We struggle to see cable extend its rally to $1.25 and beyond, but it will undoubtedly be primarily a dollar/risk sentiment story driving the pair before the BoE meeting. A contraction below $1.20 seems more appropriate given global and UK macro fundamentals," ING strategist Francesco Pesole said.

To boot, the economy is facing a wave of strikes from public sector workers this month in protest over pay as households and businesses face a cost-of-living crisis.

Prime Minister Rishi Sunak, in power for just over a month, faces a raft of problems, including a possibly lengthy recession in the run-up to an election that opinion polls suggest the Conservatives will lose.

Investors initially cheered the appointment of Sunak and his new finance minister, Jeremy Hunt, as the two brought much-needed stability to UK markets.

But that optimism is fading, which could ultimately spell more weakness for the pound.

"If you look at UK fundamentals - a strike a day in the month of December, we’ve seen a slew of Tory MPs not standing again because they don't want to be in opposition," Rabobank's Foley said.

"What that says to me is: a) the economic news is pretty grim and b) it's going to be very difficult for Sunak not to manage just the economy, but his own party," she said.

(Reporting by Amanda Cooper; Editing by Bernadette Baum)