By Gertrude Chavez-Dreyfuss

NEW YORK (Reuters) - The dollar fell on Tuesday from its highest level in more than two years, undermined by data showing weakness in the U.S. manufacturing sector and a lower-than-expected rise in construction spending.

Against the yen, the dollar slid from two-week highs, as the weak manufacturing report fueled concerns the United States may be headed for recession.

Data showed the U.S. manufacturing sector contracted in September to its weakest level in more than a decade as business conditions worsened amid U.S.-China trade tensions.

The Institute for Supply Management (ISM) said its index of national factory activity fell to 47.8, the lowest reading since June 2009. A reading below 50 signals the domestic factory sector is contracting.

"Our guess is that this weakness is at least partly due to the all-out strike at GM, which began in mid-September," said Paul Ashworth, chief U.S. economist at Capital Economics in Toronto.

The United Auto Workers a few weeks ago launched the first company-wide strike at General Motors Co (NYSE: GM) in 12 years.

Ashworth added that the ISM report reinforces the firm's belief "despite the hawkish protestations of some officials in recent days, the Federal Reserve will still cut interest rates by a further 25 basis points" at the December meeting.

The dollar was also pressured by a report showing U.S. construction spending barely rose in August.

The greenback's outlook though remained solid despite Tuesday's weak data, analysts said.

"Even though the Fed is lowering interest rates, the dollar is not exactly losing ground because of the domino effect: everybody is following the Fed in cutting rates," said Juan Perez, senior currency trader at Tempus Inc in Washington.

"With an economy that's growing at 2% on a quarterly basis while the rest of the world is struggling, the dollar looks like to be the safer asset."

Elsewhere, the Australian dollar also underperformed on Tuesday after the Reserve Bank of Australia cut interest rates and expressed concern about job growth.

With rate cuts in Australia, final PMI readings in Europe at seven-year lows, and weak confidence readings in Japan, the dollar scored its biggest quarterly gain in the third quarter since June 2018.

On Tuesday, a September survey showed euro zone manufacturing activity had contracted the most in almost seven years.

In late afternoon trading, the dollar index <.DXY> was down 0.3% at 99.12, after earlier touching 99.58, its highest since May 2017.

The euro was up 0.3% against the dollar at $1.0935 .

In Japan, its big manufacturers' business confidence worsened to a six-year low in the July-September quarter, the Bank of Japan's closely-watched Tankan survey showed.

The yen initially weakened after the Tankan data, but firmed against the dollar after the weak U.S. manufacturing report. The dollar was last down 0.4% against the yen at 107.70 yen .

The Australian dollar fell 0.7% to US$0.6710 after the RBA cut its cash rate to a record low of 0.75%.

(Graphic: CESI and euro positions link: https://fingfx.thomsonreuters.com/gfx/mkt/12/6657/6588/CESI%20and%20euro%20positions.png)

(Reporting by Gertrude Chavez-Dreyfuss in New York; Editing by Larry King, Matthew Lewis, Tom Brown and David Gregorio)

Forex Reuters