FINANCIAL MARKETS : Dollar Falls on Rate Cut Fears; Dow Off 25.93

The dollar plummeted Thursday, dropping nearly 3% against the German mark--its largest one-day loss in 2 1/2 years--on international jitters and growing speculation that the Federal Reserve Board may cut interest rates.

Stocks also were broadly though modestly lower, pressured by the falling dollar and by concerns that the economy is decelerating too rapidly, threatening corporate profits.

But bonds’ rally continued, pushing longer-term yields lower.

The catalysts for the dollar’s slide were reports suggesting that the U.S. economy’s decline may be far more pronounced than expected, and rumors about new debt problems in Mexico.

The Labor Department said initial unemployment claims grew a surprising 13,000 last week, and the National Assn. of Realtors reported that sales of previously owned homes fell 6.4% in April.

Currency traders, who had been pushing the dollar higher in recent weeks, suddenly began dumping it again Thursday, on fears that the Fed may begin cutting short-term interest rates sooner than later to revive the economy.

Lower U.S. rates could diminish the appeal of dollar-denominated investments to foreigners.

What’s more, worries about the escalating U.S.-Japan trade dispute also began to pressure the dollar Thursday, traders said.

The greenback also came under pressure as rumors circulated in the market that Mexico may default on its debt obligations. Those rumors apparently followed comments Wednesday by Sen. Alfonse D’Amato (R-N.Y.), who said Mexico’s “economy is in shambles” and that optimistic accounts of a recovery are misleading.

By the close of trading in New York, the dollar had sunk to 1.398 German marks, down from 1.440 on Wednesday. It also fell to 84.81 Japanese yen, down 2.7% from 87.23 on Wednesday.

Stocks, cuing off the dollar and economic worries, closed lower. The Dow Jones industrials lost 25.93 points to finish at 4,412.23, though most broader indexes were down only slightly, and losers edged winners by just 1,180 to 1,056 on the New York Stock Exchange.

Meanwhile, bonds recovered from a midday selloff, and yields ended mostly lower. The yield on the Treasury’s main 30-year bond closed at 6.72%, down from 6.74% Wednesday and a 15-month low.

Among the market highlights:

* Industrial stocks most sensitive to the economy’s swings fell most. International Paper dropped 1 3/4 to 78 3/8, Alcoa fell 1 1/4 to 46 7/8 and Caterpillar lost 1 1/8 to 59 1/8.

* On the plus side, classic consumer growth stocks saw renewed buying. Procter & Gamble added 1 1/4 to 70 1/4, while Merck climbed 1 to 45 1/2.

* Utility stocks, also a classic “defensive” holding in a weak economy, shot up. The Dow utility index leaped 1.8% to 201.75.

* Among new stock issues, game software maker Maxis rose 4 to 20 in its first day of trading, and Uunet, a computer products maker, climbed 12 to 26 in its debut.

In foreign trading, the rumors about Mexico sent the Bolsa stock index plunging 44.72 points or 2.2% to 2,000.11.

Tokyo stocks were hit again, with the Nikkei 225-share average off 391.31 points at 15,579.44.