Dollar drops as housing, trade concerns weigh

NEW YORK (Reuters) - The dollar dropped to a two-year low against the euro on Tuesday, on persistent worries about the health of the U.S. housing market and concerns a trade dispute between the United States and China is escalating.

Investors sold the dollar, nagged by concerns that weakness in the U.S. housing market may be broadening after a sharp decline in the shares of American Home Mortgage Investment Corp. AHM.N, which had lowered its earnings forecast.

Dollar bears are betting that a weaker housing market will prompt the Federal Reserve to cut interest rates as early as mid-year, reducing the greenback's appeal to investors hunting for high yields.

As liquidity returned to the market after Easter holidays, an intensifying trade dispute between China and the United States also hurt the dollar, traders said. The United States on Tuesday accused China at the World Trade Organization of piracy and blocking access to U.S. films, books and software.

"We're back into some of the themes that we have been focusing for some time such as worries about the housing sector in the U.S. along with a possible interest rate cut maybe by the fall. So all those factors are pushing for a weaker dollar," said Steven Butler, director of foreign exchange trading at Scotia Capital in Toronto.

"Trade protectionism is also starting to worry other people. That is certainly viewed as a negative for the U.S. economy," he added.

The yen hit a record low against the euro after the Bank of Japan left interest rates on hold at 0.5 percent -- the lowest rate in the industrialized world -- and gave no sign that Japanese rates will rise anytime soon.

The euro rose as high as 160.10 yen EURJPY= on the EBS electronic trading system, a record since the euro's launch in 1999. By mid-afternoon in new York, it traded back down to 159.94 yen. The dollar was down 0.2 percent at 119.11 yen JPY=, off a six-week high of 119.39.

Against the dollar, the euro was up 0.5 percent on the day at $1.3425 EUR= after climbing to a peak of $1.3457, the highest level since March 2005.

The European Central Bank holds a monetary policy meeting this week. The ECB is expected to leave rates on hold at 3.75 percent on Thursday, before raising them again this year, perhaps in June or sooner.

Analysts said the market would be on the lookout for any signals from ECB President Jean-Claude Trichet that a rate hike is imminent, which would likely buoy the euro.

"The risk scenario, given recent strong data, would be that President Trichet could employ the key 'vigilance' phrase, which would pave the way for a move in May," strategists at UBS wrote in a note to clients.

One of the day's most notable gainers was the Australian dollar, which rose to its highest since 1990 against the U.S. dollar as robust domestic economic data boosted expectations for another rise in Australian interest rates next month.

The Aussie dollar was up 1.1 percent at US$0.8255 AUD= after touching a peak of US$0.8260 also gaining support from news Australia's Rinker Group RIN.AX had told its shareholders to accept a $14 billion Mexican takeover bid.

The New Zealand dollar followed suit, rising 1.2 percent to US$0.7305, the highest in almost two years.