Sterling declined on Monday as initial investor optimism regarding signs of easing Covid curbs in China weakened, and the Dollar kicked off Monday on the back foot.

In morning trading in London, the majority of the risk rally that saw the Pound reach a session high of $1.2345 faded, resulting in the Pound edging down 0.3% to $1.2259. Against the Euro, it fell 0.4% to 86.13 pence.

Last month, the Sterling increased by 5.2% against the greenback, its strongest monthly performance since 2020. However, considering the UK's gloomy economic outlook, the currency may struggle to make more progress, Reuters news agency reports.

"For Sterling, it could be a case of 'too much, too soon'," according to Rabobank head of currency strategy Jane Foley in regard to Sterling's gains last month.

The majority of the Dollar's weakness seen recently has been fuelled by mounting predictions the Fed will announce a 50-basis point rate hike this month, following four consecutive 75-basis point increases.

According to data published last Friday, the US economy generated more jobs than anticipated in November, making it tougher for the Fed to warrant a rate hike slowdown when inflation is still high.

In the UK, money managers still maintain a bearish stance towards the Pound, per Commodity Futures Trading Commission (CFTC) data. Despite still holding a net short position, it is over 50% smaller than those seen earlier in the year. 

"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," said ING strategist Francesco Pesole.

The Prime Minister is facing a likely lengthy recession in the lead-up to an election that, according to opinion polls, the Conservatives could lose.

Investors primarily praised Rishi Sunak becoming PM and Jeremy Hunt's appointment as Chancellor, as they brought stability to UK markets, the Reuters report adds. Yet this level of optimism is waning, which could result in more Sterling weakness.