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TOKYO, July 3 (Reuters) - The dollar matched a 26-year low versus sterling and hung near a record trough against the euro on Tuesday as investors confident that U.S. interest rates will hold steady flocked to currencies whose rates are expected to keep climbing.

Traders also sold the dollar ahead of a U.S. national holiday on concerns that the United States may be a terrorism target following an attack on Glasgow airport and foiled attempts to detonate car bombs in London late last week.

High-yielding currencies remained well-supported, helping to keep the Australian dollar near an 18-year high hit against the dollar on Monday, while the New Zealand dollar hovered around its strongest since the currency was floated in 1985.

''Interest rates are a big driver of the market this week, so currencies whose rates are expected to rise are benefiting,'' said Hideaki Inoue, forex manager at Mitsubishi UFJ Trust and Banking.

He said this view would continue to batter the low-yielding yen, which many investors have been using to fund purchases of assets in higher-yielding currencies in carry trades.

Sterling has shot up in the past few sessions before the Bank of England holds a policy meeting this week at which it is expected to lift rates 25 basis points to 5.75 percent, which would be half a percentage point higher than U.S. rates.

The BoE will announce its decision on Thursday.

Sterling traded at $2.0165 after rising to $2.0185 earlier in the day and matching a 26-year high hit on Monday.

The euro was little changed at $1.3620 hovering near a record high around $1.3680 hit in April.

It was at 166.50 yen slipping 0.15 percent before a slew of expected European bond redemptions later in the week. Despite Tuesday's slide, however, the single currency lingered near a record high just under 167.00 yen touched last week.

The European Central Bank also holds a policy meeting this week, and although it is widely seen keeping rates steady at 4.0 percent this month, the central bank is expected to lift rates in the next few months.

The dollar traded around 122.20 yen near a three-week low of 122.09 yen touched on Monday.

Although the dollar index barely hovered above its lowest point since March 2005 at about 81.405 on Tuesday, its slide against the yen has been limited as investors continue to sell the low-yielding yen even as the Bank of Japan is expected to lift rates to 0.75 percent as early as August.

Traders said the market will be watching to see if the dollar makes a sustained fall below 122 yen -- a level that traders expect will trigger buying from players including retail investors keen to pick up the dollar on the cheap.

DOLLAR JITTERS The Australian dollar fell around 0.2 percent against the dollar to $0.8555 due to a surprising fall in Australian retail sales for May, but the currency hovered near an 18-year high hit the previous session.

The New Zealand dollar slipped a touch in early trading due to market chatter that the Reserve Bank of New Zealand may be selling the currency after it shot up to $0.7835 on Monday, the kiwi's highest since it was floated in 1985.

At 0245 GMT, it was little changed at $0.7815.

A suicide bombing in Yemen on Monday, suspected to be linked to al Qaeda, had boosted the U.S. Treasury market, pushing benchmark yields to their lowest level in nearly a month and keeping traders on alert for the possibility of an attack on U.S. soil during the country's Independence day holiday on Wednesday.

Such jitters kept investors away from the dollar, in addition to continuing woes in the sub-prime mortgage market and the view that the Federal Reserve is unlikely to lift rates anytime soon given a recent run of data showing soft U.S. inflation.

'All of this is exaggerating dollar selling,'' said Tomoko Fujii, senior economist and strategist at Bank of America.

But she added that pressure to dump the dollar may subside after the holiday, when traders return to the market and brace for U.S.

employment data for June due on Friday.

REUTERS GL VC1045