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TORONTO (Reuters) - Canada's dollar looks set to outperform its commodity-linked peers and the euro in the near term as spiking Italian bond yields ratchet up Europe's debt crisis and threaten global growth.
Analysts say Canada's proximity to the still-expanding U.S. economy - and the fact its interest rates are unlikely to fall - should help it do better than other so-called pro-cyclical currencies, which are closely tied to economic growth and risk appetite.
While the Canadian dollar weakened more than 1 percent against the greenback on Wednesday, it rose against other major currencies, with the exception of the Japanese yen.
Many strategists expect that trend to play out through the rest of 2011.
"I'm anticipating a relatively strong U.S. dollar into the end of the year and in that environment, the Canadian dollar tends to better than the other dollar-bloc currencies and better than the major European currencies," said Marc Chandler, global head of currency strategy at Brown Brothers Harriman in New York.
"Because there's more downside for the euro, I think that an attractive trade idea would be long Canada dollars, short euros."
The most recent catalyst for fleeing riskier assets came on Wednesday, when global stocks, commodity prices and the euro took a pounding after Italy's 10-year bond yields rose above the precarious 7-percent level. Yields at that level have caused other euro-zone countries such as Greece, Ireland and Portugal to seek bailouts. <MKTS/GLOB>
With a debt burden of about 1.9 trillion euros, Italy is considered too big to bail out, and a default would probably dry out credit, bring Europe to a recession, and drag on global growth.
In this environment, the currencies of both European countries and big commodity exporters such as Australia and New Zealand would be likely to suffer. While Canada would also take a hit, its growth prospects would be relatively stronger.
"Because of Canada's physical trade links with the U.S., when the (U.S.) dollar is doing well, that tends to have some spillover effect into the Canadian dollar. But it doesn't for Australia and New Zealand, for instance," said Adam Cole, global head of FX strategy at RBC Capital Markets in London.
"The market is kind of lining currencies up according to their riskiness and trading them on that, and really isn't thinking much more deeply than that at the moment," said Cole, who also noted the Canadian dollar's outperformance against other pro-cylical currencies such as Sweden's and Norway's.
Other strategists have referred to Canada as a lower-risk currency in the commodity bloc, less vulnerable to the prospect of slowing Chinese growth than the Aussie dollar, for instance.
"CAD has really taken over as a low beta currency, very much like sterling, outperforming on days when the U.S. dollar is strong and underperforming on days when the U.S. dollar is weak," said Camilla Sutton, chief currency strategist at Scotia Capital.
She also pointed out that Canada doesn't have the interest rate differential that Australia has with many other currencies, leaving it less vulnerable to the prospect of rate cuts that could trigger selling.
The Reserve Bank of Australia cut rates to 4.5 percent last week. The Reserve Bank of New Zealand has its key interest rates at 2.5 percent.
The Bank of Canada's key policy rate is at 1 percent. Canada's primary dealers don't expect a cut and most think the central bank will resume raising rates by mid-2012 or 2013.
Editing by Jeffrey Hodgson and Peter Galloway