C$ rallies on BoC's surprise tone on rates

TORONTO: Canada's dollar shot to its highest level against the US currency in more than a week on Tuesday, while and bond prices retreated, after the Bank of Canada surprised investors with some hawkish talk in its policy statement.

But the rally cooled a bit by the end of the session as the market came to terms with possibly having to wait a few more months for rate increases to resume, and as worrisome US economic data cast a shadow over Canada's growth prospects.

The central bank kept its key interest rate unchanged at 1 percent but seemed to convince the market that it will have to lift borrowing costs "eventually" if economic growth continues.

After the announcement, the currency climbed as high as C$0.9653 to the US dollar, or $1.0359, up from C$0.9723 to the US dollar, or $1.0285, immediately before the scheduled release. It was the Canadian dollar's strongest level since May 20.

"It certainly was the key driver in the rally. We were with most other currencies in a risk-on tone earlier on and when the Bank of Canada came out and clearly indicated an upward bias to rates in Canada, that certainly had a distinct impact on the Canadian dollar," said David Watt, senior fixed income and currency strategist at RBC Capital Markets.

"It faded through the rest of the day as the market read the statement and saw that the Bank of Canada isn't pounding on the table calling for a rate hike right now, but eventually," he adding, noting weak US economic data didn't help.

A slew of US reports showing a double-dip in home prices, pessimistic consumers and a slowdown in regional manufacturing raised concerns that the US economy's soft patch could become protracted.

The Canadian dollar closed the North American session at C$0.9686 to the US dollar, or $1.0324, up from C$0.9771 to the US dollar, or $1.0234, at Monday's close.

The move finally pushed the currency out of its tight C$0.9735-C$0.9817 range in the last six sessions.

The Bank of Canada is expected to resume raising interest rates in September, according to a Reuters poll of primary dealers conducted after the announcement.

Overnight index swaps, which trade based on expectations for the key central bank policy rate, also showed investors slightly reducing the likelihood of a rate hike in July, but increasing the odds of tightening in September, October and December.

"I think the bank was uncomfortable with the market starting to assume that it was going to wait forever to begin hiking and with the resulting impact on mortgage rates, which have been falling," said Avery Shenfeld, chief economist at CIBC.

Notably for Canadian-dollar bulls, the currency ended stronger than its 100-day moving average of C$0.9753.

Watt said the 50-day moving average around C$0.9648 was the next near-term resistance level for the Canadian dollar after stopping just short of that mark in its jump on Tuesday.

The currency was already on firmer footing heading into the Bank of Canada statement as global risk sentiment was lifted by a risk-on tone in the market on optimism over an aid package to deal with Greece's debt crisis.

BONDS PRICES LOWER

Canadian bond prices ended lower as investors were caught off guard by unexpectedly hawkish language in the Bank of Canada's policy statement.

They cut some losses, but still underperfomed rising US Treasuries after disappointing US data overshadowed optimism for an easing of the euro zone debt crisis.

Canada's two-year bond was down 16 Canadian cents to yield 1.590 percent, while the 10-year bond dropped 10 Canadian cents to yield 3.075 percent.

Copyright Reuters, 2011