* Euro falls to lowest in more than 3 months vs dollar
* Fall in Aussie dollar triggers euro break
* Dollar also firm on yen as domestic politics weigh
* Dollar index hits fresh 3-year high (Corrects format of headline)
By Charlotte Cooper
TOKYO, March 4 (Reuters) - The dollar climbed to its highest in more than three months against the euro on Wednesday and forged to a three-year high against a basket of currencies as a drop in the Australian dollar set off a chain reaction.
The yen edged lower as the arrest of a close aide to Japan's opposition leader in a fund-raising scandal clouded an already uncertain political picture in an election year.
But the catalyst for the dollar's push came from Australia, where figures showed the economy unexpectedly contracted last quarter for the first time in eight years, sending the Australian dollar tumbling and taking the euro with it.
"The Australian GDP was the trigger for all of the dollar buying," said Minoru Shioiri, chief manager of forex trading at Mitsubishi UFJ Securities.
"I personally feel that the dollar has been bought too much, but it may extend its broad gain if the euro struggles to recover above $1.2500," he said.
The euro fell as far as $1.2457 on trading platform EBS to its lowest in more than three months, before ticking back up to $1.2495 to stand 0.5 percent down on the day.
The dollar index climbed to a fresh three-year peak at 89.624, fast approaching 89.90, which would mark a 38.2 percent technical retracement of its long-term decline from 2001 to 2008.
The Australian dollar tested its lowest levels in more than a month at $0.6285, taking fellow high-yielder the New Zealand dollar down with it to a six-year low of $0.4895.
Traders said the euro also drew fire ahead of Thursday's meeting of the European Central Bank, which is expected to cut interest rates to a record low of 1.5 percent from 2.0 percent.
ECB Governing Council members Axel Weber and Christian Noyer said on Tuesday the central bank was considering all options to extend its monetary toolbox further..
POLITICAL CLOUDS
The yen pared the steepest of its losses after opposition Democratic Party leader Ichiro Ozawa said he would not resign over the arrest of a close aide in a fundraising scandal.
But the affair cast a cloud over his party's prospects in an election that must be held by October.
Analysts are concerned the scandal dims hopes that a national poll could break a parliamentary deadlock and policy paralysis.
The yen has already lost favour after Japan's finance minister resigned last month and as the economy, which many had once expected would weather the global economic storm quite well, struggles with a collapse in export markets and mass lay-offs.
"Compared to the fragile state of U.S. and European banks getting tens of billions of dollars in capital injections, the domestic financial system is stable, giving the yen relative strength," said a senior trader at a Japanese bank.
"Yet, a big problem with the yen is the political situation in Japan. That is definitely factor behind the dollar/yen's recent firmness," the trader said.
The dollar gained 0.3 percent to 98.42 yen, edging closer to last week's high of 98.72, its strongest level since early November.
Investors were also looking to U.S. economic data due later in the day including a monthly private survey, which could set a tone for the government's non-farm payrolls data on Friday.
Economists expect the ADP national employment index due at 1315 GMT to show a loss of 610,000 jobs in February. (Additional reporting by Rika Otsuka and Satomi Noguchi; Editing by Edwina Gibbs