The dollar tumbled to a 26-year low against sterling and declined across the board on Monday on continuing expectations that U.S. interest rates will remain steady while borrowing costs rise overseas.

The dollar fell earlier to within half a cent of a record low against the euro, extending Friday's heavy losses in the wake of soft reports on U.S. consumer price inflation and personal income and spending.

A reading on manufacturing activity released on Monday had little impact on markets. Reports on factory orders, durable goods and June payrolls are to be released later this week.

The outlook for rates doesn't favor the dollar in the near term, but it may be too soon to completely write off the currency before we see the remaining economic releases and the central bank meetings still due this week, said Samarjit Shankar, director for global strategy at Bank of New YorkMellon in Boston.

The Bank of England is expected to raise interest rates on Thursday. The European Central Bank, which is expected to leave interest rates on hold when it meets on Thursday, is also expected to tighten monetary policy in coming months, reducing the relative allure of the dollar at a time when the Federal Reserve is expected to keep U.S. interest rates on hold.

The euro was 0.6 percent higher at $1.3622 in late afternoon New York trade and in sight of a record high just above $1.3680 hit in April. The dollar was down 0.6 percent at 122.32 yen.

Sterling earlier hit a 26-year high versus the dollar at $2.0174 ahead of the Bank of England's meeting on Thursday when it is expected to raise rates by a quarter percentage point to 5.75 percent -- half a percentage point higher than U.S. borrowing costs.

Reflecting the dollar's waning yield advantage, the 2-year Treasury note now yields about 40 basis points more than euro-zone debt of the same maturity, around the narrowest gap in two and a half years.

The dollar's chief vulnerability appears to be a continued loss of yield support as U.S. yields edge lower relative to the rest of the G10, strategists at UBS AG wrote in a note to clients on Monday.

The New Zealand dollar touched a high of US$0.7835, its highest point since the central bank allowed the kiwi to trade freely in March 1985.

The dollar fell 0.6 percent against a basket of major currencies, close to a two-and-a-half-year low touched on March 2005.

Trade is expected to be thinner this week due to the July 4 Independence Day holiday in the United States, which comes ahead of Friday's closely watched U.S. nonfarm payrolls report.

Security alerts in Britain may also be keeping some investors on the sidelines. Police arrested two more suspects on Monday in a hunt for members of a suspected al Qaeda cell that rammed a fuel-packed Jeep into a Scottish airport and left two car bombs in London.

Trading volumes are lower and in light of what happened in the UK during the weekend most investors will just avoid going long on dollar until this week ends without any incident, said Gregory Salvaggio, vice president for trading at Tempus Consulting in Washington.

(Additional reporting by David McMahon)

European union