The decision is the latest in a series of trade rulings against the United States, and comes less than a week before the European Union is scheduled to begin imposing $200 million's worth of sanctions on U.S. goods as part of a separate dispute.
The impact of any potential retaliation relating to Tuesday's WTO decision remained unclear. The WTO said the European Union would have to show proof that its companies had suffered damage from the 1916 law before it could retaliate.
The U.S. law provided for civil and criminal penalties, including fines and imprisonment, for foreign companies found to be "dumping" goods at prices below their value to undermine U.S. competitors.
The WTO, acting on an EU complaint supported by Japan, ruled the law was illegal in March 2000 because under WTO rules, import tariffs are the only remedies permitted as a response to dumping.
The law had been considered obsolete until Wheeling-Pittsburgh Steel Corp. brought a lawsuit against importers of Russian and Japanese steel in 1998. Last December, a federal jury awarded an Illinois company $31.5 million in a separate dumping case against a Japanese company. Three European companies are still facing similar actions, according to the European Union.
Under the WTO ruling, the European Union will be able to retaliate against U.S. firms for up to the value of any sanction imposed under the law or for the cost of any out-of-court settlement.
Washington has vowed to keep working with Congress to get the law dropped and said that the WTO ruling posed no immediate threat to U.S. companies because the European Union had not shown any measurable damage from the law.
"We do not believe this will pose a problem. If Congress continues to make progress and repeals the 1916 act, this matter will be resolved," Richard Mills, a spokesman for the U.S. Trade Representative's Office, told Reuters.
EU Trade Commissioner Pascal Lamy described the decision as a "welcome reaffirmation that the WTO is a rule-based system and members may not ignore their obligations with impunity."
He also noted retaliation could still be avoided if Congress repealed the law.
"I hope that rapid action from Congress will make sanctions unnecessary," he said.
Meanwhile, U.S. and European businesses are hoping that the sanctions scheduled for Monday will not lead to a larger trade war.
The American Chambers of Commerce in Germany and the BritishAmerican Business Inc. said in a statement that they "encourage the United States Congress to comply as quickly as possible with the WTO ruling."
The initial impact of the sanctions on business should be limited since as they represent a small percentage of the billion-dollar-a-day trade between the European Union and the United States.
Despite the relatively small size of the sanctions, the Associated Press reported that the European industry group UNICE was worried about a trade dispute between the two parties and asked Lamy to consider granting the United States a phase-in period for a system to replace the existing tax breaks.
The WTO's recent decisions against the United States come as the leading Democratic candidate for president, Sen. John Kerry of Massachusetts, and his main rival, North Carolina Sen. John Edwards, have promised to be more aggressive in defending U.S. trade interests than President Bush.