October 19, 2012 / 8:43 PM / 5 years ago

Canada dollar marks worst week since May

Canadian one hundred dollar bills are displayed in this posed photograph in Toronto, October 22, 2008.Mark Blinch

TORONTO (Reuters) - The Canadian dollar dropped near a two-month low on Friday and marked its worst weekly performance since May on growing expectations that the Bank of Canada will sound more dovish when it sets interest rates next week.

Prices in Canada remained tame in September with inflation at 1.2 percent, unchanged from August. The absence of inflation pressure could set the stage for the central bank to ease its hawkish bias when it holds its next policy meeting on Tuesday.

"A lot of traders were readjusting their expectations this morning," said Mark Frey, chief market strategist at Cambridge Mercantile Group, in Victoria, British Columbia.

Higher interest rates tend to help a country's currency appreciate because they often attract international capital flows and vice versa.

Canada's risk-related currency was also vulnerable to the perceived lack of progress on a Spanish bailout request, which reminded investors of the headwinds facing the global economy.

"Today's data aside, the overall macro environment and risk with respect to equities and commodities is what drives the Canadian dollar nine days out of 10," added Frey.

The Canadian dollar ended the North American session at C$0.9932 to the greenback, or $1.0068, compared with C$0.9849, or $1.0153, at Thursday's close.

The currency hit an intraday low of C$0.9939, or $1.0061, its weakest level since August 24. It marked the biggest one-day drop in four months.

The Canadian dollar was down 1.4 percent for the week, its steepest weekly decline in five months.

The next significant support levels for the Canadian dollar were seen around C$0.9960, followed by parity.

The currency has fallen more than 1 percent this week, underperforming other major currencies after Bank of Canada Governor Mark Carney omitted previous language on possible interest rate hikes in a speech he gave on Monday.

Carney did say that the central bank would take whatever action is necessary to keep the 2 percent inflation target and acknowledged the effect global uncertainty was having on Canada's resource-linked economy.

"The (inflation) report should weigh towards a softer dollar, given the implications for the Bank of Canada," said Sal Guatieri, senior economist at BMO Capital Markets.

Overnight index swaps, which trade based on expectations for the central bank's key policy rate, showed that after the inflation data traders slightly increased their small bets on a rate cut in the coming year.

A Reuters poll released on Thursday suggested the central bank will postpone interest rate hikes until the fourth quarter of next year and will likely water down, rather than eliminate, its hawkish language.

Declines in the price of oil, gold and copper also weighed on the commodity-linked currency, while a handful of disappointing U.S. earnings reports added to the pessimistic tone.

Tech giants Microsoft (MSFT.O) and Google (GOOG.O) issued lackluster earnings on Thursday, while General Electric (GE.N) reported revenue early on Friday that fell short of expectations.

Besides the Bank of Canada policy announcement and monetary policy report next week, investors will also be paying close attention to the Federal Reserve rate decision U.S. third quarter growth data.

Canadian government bond prices rallied on renewed demand for safe-haven assets, mimicking U.S. Treasuries. <US/>

The rate-sensitive two-year bond outperformed its U.S. counterpart, rising 8 Canadian cents to yield 1.090. The benchmark 10-year bond jumped 47 Canadian cents to yield 1.846 percent.

Additional reporting by Alastair Sharp; Editing by M.D. Golan

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