TORONTO (Reuters) - Canada's dollar sagged against its U.S. counterpart on Friday as weaker-than-expected inflation data gave the Bank of Canada more breathing room to keep interest rates low or cut them if Europe's debt problems worsen.
Slower growth in gasoline prices and lower vehicle costs helped push down the consumer price index by 0.6 percent in December, resulting in annual inflation slowing to 2.3 percent from 2.9 percent in November.
The annual core rate, a more accurate picture of underlying price pressures, fell to 1.9 percent from 2.1 percent. Analysts surveyed by Reuters had forecast, on average, annual inflation of 2.8 percent in December and a core rate of 2.1 percent.
"The early driver was the CPI miss. That caused the Canadian dollar to lag the broader market," said Jack Spitz, managing director of foreign exchange National Bank Financial.
Higher interest rates tend to help currencies strengthen by attracting international capital flows, and the prospect of monetary easing typically weakens them.
Most economists expect the central bank to hold rates steady and begin hiking in 2013. <CA/POLL>
"For the Canadian dollar, it just takes some of the pressure off of the Bank of Canada," said Camilla Sutton, chief currency strategist at Scotia Capital.
The Canadian dollar finished the session at C$1.0132 to the U.S. dollar, or 98.70 U.S. cents, after hitting a session low of C$1.0165 to the U.S. dollar, or 98.38 U.S. cents immediately after the inflation headlines landed. It closed at C$1.0114 on Thursday.
The currency firmed about 1 percent for the week.
Spitz said weaker oil prices and market uncertainty about Greece's debt restructuring talks also weighed on the commodity sensitive Canadian dollar. <MKTS/GLOB>
Greece was closing in on an initial deal with private bond holders on Friday that would prevent it from tumbling into a chaotic default but lose investors up to 70 percent of the loans they have given to Athens.
"We're going into a weekend and the market continues to remain extremely sensitive to the headline risks that come predominantly out of Europe," said Spitz.
"The ongoing headline risks all have lent themselves to the squaring of positions going into this weekend. That's ultimately been a major factor in terms of the flow."
Spitz said he expects a near-term trading range for the Canadian dollar between C$1.0070-C$1.0220 against the greenback.
Canadian government bond prices were mostly lower with the two-year bond falling 3 Canadian cents to yield 1.045 percent. The 10-year bond dropped 51 Canadian cents to yield 2.066 percent.
Editing by Jeffrey Hodgson