The dollar dropped to a record low against the euro on Thursday as troubles in the U.S. mortgage and credit markets continued to dampen the currency's appeal.

The dollar also hovered around a two-and-a-half-year low against a basket of six major currencies, as investors worried that credit market problems could hurt the economy and lead the Federal Reserve to cut interest rates by year-end.

There is still some jitters about the subprime issue and that's still weighing on the dollar, said Nick Bennenbroek, head of FX strategy at Wells Fargo in New York.

Subprime loans are extended to borrowers with poor credit histories.

There's some concern about the economy, that troubles in those sectors will spread to other areas of financial markets and cause a broader slowdown. Also, we have seen expectations of a rate cut start to come back into calculations and this is a reflection of the subprime jitters, he added.

Early in New York, the euro was up 0.2 percent on the day against the dollar at $1.3770, having set a record high of $1.3799. The single currency also hit a lifetime peak at 168.65 yen, according to electronic trading platform EBS, before trading back down to 168.48, up 0.2 percent on the day.

U.S. data showing the trade deficit widened as expected in May had marginal impact on the dollar.

The trade numbers are roughly in line with expectations, but we are going to keep seeing the dollar declining from here, said Mark Meadows, a market analyst at Tempus Consulting in Washington. There's very little in terms of economic data in the near term that could lift it.

The dollar index was little changed at 80.713, having fallen to its lowest level in more than two years on Wednesday at 80.545. The Federal Reserve's broad nominal dollar index fell to its lowest level in a decade.

Against the yen, the dollar was flat at 122.35 yen. The yen earlier took advantage of the dollar's malaise after the Bank of Japan left interest rates on hold at 0.5 percent, as expected.

Broader yen gains were short-lived however, with the ultra-low yielding currency sliding to record lows versus the euro as investors remained skeptical on the chances of an August BOJ rate increase.

Analysts had expressed surprise at the yen's initial rebound as BOJ policymakers voted 8-1 to keep rates on hold, a sign that monetary tightening may be at least a couple of months away.

The dollar's selloff this week was triggered by reports from credit rating agencies Standard & Poor's and Moody's Investors Service on Tuesday that warned of downgrades to more than $17 billion of debt related to risky mortgages, much of it subprime.

This has prompted interest rate futures markets to go back to pricing in a Fed rate cut later this year. That is eroding the dollar's yield appeal as other central banks, such as the European Central Bank, Bank of England and eventually the BOJ are in tightening mode.

(Additional reporting by Vivianne Rodrigues in New York and Veronica Brown in London)

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