By Harry Robertson

LONDON, Dec 31 (Reuters) - The pound was little changed on the final trading day of the year on Tuesday, leaving it on track to be the best performing major currency against the dollar this year as the UK economy has held up better than expected.

Sterling has fallen 1.4% across the year as expectations about British and U.S. interest rates have moved broadly in line with each other. That has limited divergence between the two countries' bond yields, which drive currencies by making fixed-income investments more or less attractive.

The pound GBP=D3 was flat at $1.2554 on Tuesday, having started the year at $1.273.

Investors broadly expect the Bank of England to cut interest rates two times next year after two cuts in 2024. BoE officials remain concerned that inflation in services and wages remains too high.

"There has been progress in disinflation, particularly as previous external shocks have abated, although remaining domestic inflationary pressures are resolving more slowly," the BoE's Monetary Policy Committee said earlier this month.

However, sterling was on track for a drop of more than 6% in the fourth quarter, reflecting a rally in the dollar as the U.S. Fed took a tougher stance on inflation as well as signs of weakness in the UK economy.

BoE officials were more split than expected as they voted to hold rates this month, with three voting for a reduction.

Britain's economy contracted in September and October, the first back-to-back shrinkage since the COVID-19 pandemic.

The pound has fared much better against the euro, rising around 4.5% this year. The euro zone economy has slowed more than expected, leading the ECB to cut rates relatively sharply and investors to pencil in more for next year.

The euro fell as low as 82.23 pence earlier this month, its weakest in two and a half years and not far off levels seen just after the Brexit vote in 2016, which caused the pound to slide.

It last traded 0.1% higher on the day at 82.98 pence EURGBP=D3.

(Reporting by Harry Robertson; Editing by Sharon Singleton)