March 31 (Bloomberg) -- The dollar dropped against the euro and the yen this week after the U.S. added tariffs on imports from China, fueling concern the levies will reduce trade flow with the world's biggest holder of foreign reserves.

The U.S. currency also fell against the yen on speculation mounting tension in the Mideast will lead investors to reduce holdings in riskier assets financed by loans in Japan. The tariff and Mideast concern yesterday offset U.S. reports showing signs of a stronger economy and accelerating inflation.

``The whiff of protectionism killed off the bullish sentiment on the dollar,'' said Shaun Osborne, chief currency strategist in Toronto at TD Securities Inc.

The dollar fell to $1.3356 per euro, down 0.55 percent from March 23. The U.S. currency touched $1.3401 on the tariff announcement, the lowest level since March 22. The dollar dropped 0.23 percent to 117.85 yen. For the quarter, the dollar lost 1.19 percent against the euro and 1.03 percent versus the yen.

Brazil's real was the biggest gainer against the dollar among the 16 most active currencies tracked by Bloomberg this quarter, rising 3.72 percent. The South African rand lost the most, dropping 3.67 percent.

Trading Ties

The initial duties will range from 10.9 percent to 20.3 percent, Secretary of Commerce Carlos Gutierrez said at a press conference in Washington yesterday. The Bush administration faced pressure to expand the tariffs from steel companies, textile producers and other manufacturers and their advocates in Congress, analysts said.

China is the second-largest U.S. trading partner behind Canada and holds more than $350 billion of U.S. debt. The overall U.S. trade deficit with China reached $232.5 billion last year, the largest trade gap ever between two countries.

``The measure raises fear that China may retaliate,'' said Michael Malpede, a senior currency analyst in Chicago at Man Global Research. ``They may not keep buying Treasuries. This will make the U.S. harder to finance its deficits. In the short term people are going to sell the dollar.''

China's foreign exchange reserve is $1.07 trillion, the largest in the world. China is also the second-largest holder of U.S. Treasury securities, with $353.6 billion, trailing Japan, which has $648.8 billion.

Mideast Tensions

The dollar also weakened on a report denied by a U.S. Navy spokesman in Bahrain yesterday that U.S. investors there were told to leave because of the possibility of a conflict with Iran. A report on the Debkafile Web site, citing ``U.S. financial sources,'' said investors in Bahrain were told to halt business operation.

Investors reduced their bets on a decline in the yen against the dollar after Iran seized 15 British naval personnel March 23 in the Persian Gulf.

Crude oil prices surged to a six-month high this week on heightening concern the standoff will threaten oil shipments. Almost a quarter of the world's oil flows through the Strait of Hormuz, a strategic waterway linking the Persian Gulf with the Gulf of Oman.

``The situation in Middle East could escalate, giving another reason for people to get out of the dollar,'' said Robert Houck, chief currency trader in Minneapolis at Wells Fargo Bank. ``The overall sentiment is negative against the dollar now.''

Losses in the dollar were limited as better-than-expected data from the U.S. yesterday reduced expectation that the Federal Reserve will cut borrowing costs in the third quarter.

Stronger Growth

Personal income and spending last month gained 0.6 percent, the Commerce Department said. That was twice the increases forecast by economists. An inflation measure closely tracked by the Federal Reserve accelerated to 0.3 percent last month, while the National Association of Purchasing Management-Chicago's business barometer, a gauge of manufacturing sentiment, jumped to the highest in almost two years.

``Inflation is still on the Fed's radar screen,'' said Christian Dupont, a senior currency trader in Montreal at Societe Generale SA. ``The probability of a rate cut is a touch lower. People who want to short the dollar aren't comfortable doing that.'' A short position is a bet on a currency's decline.

The Fed on March 21 kept its benchmark interest rate at 5.25 percent, the highest level since 2001, and said in its statement future policy adjustments will depend on ``the evolution of the outlook for both inflation and economic growth.''

Fed Outlook

Fed Chairman Ben S. Bernanke on March 28 told a congressional committee that inflation was his chief concern, saying it remained ``uncomfortably high.''

Interest rate futures suggested about a 57 percent likelihood the Fed will cut its target rate for overnight lending between banks to 5 percent at its Aug. 6-7 meeting, down from a 65 percent chance on March 29.

``I don't think the Fed is going to ease any time soon,'' said Richard Franulovich, a senior currency strategist in New York at Westpac Banking Corp. ``Inflation is higher than forecast. Manufacturing is improving. This is giving the dollar a lift.''

To contact the reporter on this story: Min Zeng in New York at mzeng2@bloomberg.net.

Last Updated: March 31, 2007 08:33 EDT