Dollar rallies broadly, euro falls as data weighs

NEW YORK (Reuters) - The U.S. dollar rose to a three-week high against the euro on Tuesday, helped by persistent signs of economic weakness in the euro zone that may force its central bank to slash interest rates further.

The dollar also continued to benefit from a planned U.S. stimulus package, with investors betting this would help the world's largest economy emerge from its recession sooner than other industrialized countries.

The U.S. dollar did pare some gains after minutes from the Federal Reserve's most recent policy meeting suggested the central bank is concerned that downside risks remain substantial, although that did not dent the overall positive sentiment surrounding the dollar on Tuesday.

The euro fell broadly after a drop in euro zone inflation boosted expectations the European Central Bank will continue to cut interest rates, which would likely diminish the allure of the euro zone currency against the dollar.

"Obviously, economic data in the euro zone is just as terrible as it is in the U.S., but U.S. officials have been very proactive, actually the most proactive in combating the recession," said Matt Esteve, a foreign exchange trader at Tempus Consulting in Washington.

"With (President-elect Barack) Obama basically saying he's willing or ready to do what is needed to help the economy out of recession, build jobs over the course of the next two years, it's definitely a dollar-positive," he said.

In late New York trading, the euro eased 0.6 percent to $1.3519, after having fallen as low as $1.3311, its weakest since December 12, according to Reuters data.

Minutes of the recent meeting indicate Federal Reserve policy-makers wanted to send a clear message that they intended to keep interest rates very low for a long time to help the economy recover from a recession.

"Participants judged that communicating the committee's expectation that short-term interest rates were likely to stay exceptionally low for some time could be useful," the Fed minutes said.

EURO/STERLING FALLS, YEN OUTLOOK

In the eurozone, the ECB is expected to cut its key lending rate by 50 basis points or more at its policy meeting next week. In the run-up to the gathering, ECB officials have suggested that rates could come down more in the future.

The ECB targets inflation at just under 2 percent and many in the market think a fall below that level keeps the door open to more aggressive rate cuts from the current 2.5 percent to deal with a deteriorating economy.

Against sterling, the euro fell as low as 90.23 pence, its lowest since December 17, according to Reuters Dealing. The pair has tumbled dramatically after hitting a record high of 98.05 pence last week. It last traded at 90.35 pence, down 2.4 percent.

The dollar climbed as high as 94.63 yen, its highest since December 1. It last traded at 93.76 yen, up 0.4 percent.

Analysts cited speculation that Japanese investors are renewing their foreign investments this year, which should hurt the yen.

But given the dollar's sharp gains over the past few sessions, analysts said the greenback may be due for a short-term pullback.

U.S. data on Tuesday showing a steep drop in factory orders and pending home sales in November sparked mild dollar selling, but the greenback remained higher on the day.

(Additional reporting by Wanfeng Zhou; Editing by Dan Grebler)

(Reporting by Nick Olivari and Gertrude Chavez-Dreyfuss )