FOREX-US dollar sinks as Fed outlook, weak stocks weigh

* Dollar broadly weaker on Fed outlook, stocks' slide

* Yen, Swiss franc gain on increased risk aversion

* Euro hits near 3-week high vs dollar; ECB hike in focus (Updates prices, adds comment, changes byline)

By Gertrude Chavez-Dreyfuss

NEW YORK, June 26 (Reuters) - The U.S. dollar slumped on Thursday, hitting its lowest level against the euro in nearly three weeks, as investors reduced their expectations for a Federal Reserve interest rate rise this year, and as U.S. stocks slid.

As U.S. stocks slumped, the Japanese yen and Swiss franc gained on renewed jitters about the U.S. banking sector and the surge in oil prices to another record high. Investors on Thursday unwound risky trades funded by these low-yielding currencies.

While the Federal Reserve on Wednesday said inflation risks had increased, it did not use language that convinced markets a rate rise was likely at its next policy meeting in August.

In contrast, the European Central Bank has repeatedly said it may lift interest rates in July to fight inflation. That helped push the euro near a three-week high at $1.5766 EUR= before it eased to $1.5760, up 0.6 percent from late Wednesday.

"We still have a continuation of U.S. dollar weakness and this is still in the aftermath of the FOMC meeting and the perception that the Fed will not hike interest rates in the near term," said Matthew Strauss, senior currency strategist, at RBC Capital Markets in Toronto.

"At the same time, European officials continue to remain very hawkish," he added.

The U.S dollar fell more than 1.0 percent against the yen to 106.73 yen JPY=, a two-week low, as Goldman Sachs on Thursday urged investors to sell bank and automaker shares.

U.S. financial stocks plummeted while shares of General Motors GM.N sank more than 10 percent.

Fitch Ratings' downgrade of General Motors and Chrysler LLC's CBS.UL credit ratings also hit the dollar, as did the Dow's drop to its lowest level in 21 months.

SWISS FRANC GAINS, SURGE IN OIL

The dollar dropped 1.2 percent versus the Swiss franc to 1.0222 francs CHF=, the lowest since June 9, and posting its largest daily loss in about three weeks.

Elsewhere, sterling rose 0.7 percent to $1.9873 GBP=, near an eight-week high of $1.9896 earlier in the session.

The euro also climbed to a record high at 169.45 yen EURJPY= before easing to 168.18 yen.

The U.S. central bank's move to leave interest rates unchanged on Wednesday effectively ended one of its most aggressive rate-cutting campaigns, launched last September to curb economic fallout from the housing and credit crisis.

With rising inflation expectations, many investors are worried that the Fed is falling behind the curve.

Oil prices on Thursday shot up to a record above $140 a barrel CLc1.

"Wishing away inflation is not a prudent policy move if you are a central banker, and we fear the Fed is going to run afoul of its dual mandate, which includes price stability," said Micahel Woolfolk, senior currency strategist at Bank of New York Mellon said.

Expectations for a July ECB rate rise remained intact after data from German states pointed to an increase in inflation in the euro zone's biggest economy.

Earlier in the session, data showed the U.S. economy grew at an annualized rate of 1 percent in the first quarter, nearly double the annualized growth rate of 0.6 percent in the final three months of 2007.

In the housing sector, there are growing signs that the downturn in the sector may be nearing a bottom, as existing home sales for May came in higher than expected.

Both reports, however, failed to support the dollar, as financial sector worries persisted.

"That's about the best that could have been wished for (on gross domestic product growth), and it shows that net exports clearly contributed, but there are obviously still strong downdrafts in the banking and housing sectors," Woolfolk said. (Additional reporting by Steven C. Johnson; Editing by Jonathan Oatis)