The U.S. dollar rallied for a third straight session on Tuesday, boosted by more signs of economic weakness in the euro zone that could prompt its central bank to slash interest rates further. The dollar also continued to benefit from a planned U.S. stimulus package, with investors betting that this would help the world's largest economy emerge from its recession more quickly than most countries. The euro fell broadly, hitting a three-week low versus the greenback after a fall in euro zone inflation added fuel to expectations the European Central Bank will continue cutting rates. See [ID:nL6532861]. That should diminish the allure of the single euro zone currency against the dollar. "It's more of a euro sell-off than a dollar rally and has something to do with the fact that markets do not believe the ECB can maintain interest rates above 2 percent for much longer," said Boris Schlossberg, director of currency research at GFT Forex in New York. "On the other hand, the Obama stimulus package has also helped the dollar. The hope is that the stimulus plan would enable a quick U.S. economic rebound." Losses in the euro prompted broad dollar gains, with the U.S. currency climbing above 94 yen against the Japanese unit, its highest in more than a month, while the dollar index hit its highest in three weeks. In early New York trading, the euro was down 1.5 percent at $1.3397, having fallen as low as $1.3311, its weakest level since Dec. 12, according to Reuters data. Against sterling, the single currency fell to 91.00 pence EURGBP, its lowest since Dec. 17. The pair has tumbled dramatically after hitting a record high of 98.05 pence last week. It last traded at 91.91 pence, down 0.8 percent on the day. WEAK YEN OUTLOOK The dollar climbed as high as 94.42 yen , its highest since Dec. 1. It was last at 94.27 yen, up 1 percent. Analysts cited speculation that Japanese investors are renewing their foreign investments this year, which should hurt the yen. The ICE Futures' dollar index, a gauge of the greenback's value against a basket of currencies .DXY, rose as high as 84.023, its strongest in more than three weeks. The index last traded at 83.633, up 1.3 percent. Analysts, however, said given the dollar's sharp gains over the last few days, the currency may be due for a short-term pullback. "Short-term momentum studies are over-extended, suggesting operators may find it difficult to substantially extend the dollar's gains scored in Asia and Europe," said Brown Brothers Harriman in a research note. But the bank expected dollar buying to resume once the currency gets back to lower levels. In the euro zone, inflation fell to a 26-month low of 1.6 percent year-on-year from 2.1 percent in November. 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. "(The data) will further free the ECB to cut interest rates at next week's meeting," said Adam Cole, global head of currency strategy at RBC in London. "The balance of news from Europe is so poor that the market is perceiving that the ECB is behind the curve (on rates)," which was driving recent weakness in the euro, he said. 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 been suggested that rates could come down more in the future. (Additional reporting by Naomi Tajitsu in London; Editing by Chizu Nomiyama)

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