(Adds economists' comments, details on data, updates prices)
By Alastair Sharp
TORONTO, June 20 (Reuters) - The Canadian dollar firmed to its strongest level since the first week of 2014 on Friday after surprisingly high Canadian inflation data and robust retail sales increased speculation that the central bank will soon have to shift its policy stance.
The Bank of Canada warned investors just last week that low inflation is a lingering concern, signaling to markets its reluctance to raise interest rates. But the twin data points jolted the currency about half a cent stronger as it forced traders to rethink the rate outlook.
"Expectations of rate cuts have been pretty much eliminated here in Canada," said Paul Ferley, assistant chief economist at Royal Bank of Canada. "We will start seeing some speculation about whether rate hikes will start to come sooner rather than later."
Yields on government debt also spiked, most noticeably at the short end of the curve. And yields on overnight index swaps, which trade based on expectations for the policy rate, showed that the already slight expectation of a cut later this year had disappeared.
Costlier energy pushed annual inflation to a 27-month high of 2.3 percent in May from 2.0 percent in April, while a rise in core inflation also defied the Bank of Canada's low-inflation forecasts.
"Both of those are way higher than the Bank of Canada estimated back in April," said Krishen Rangasamy, senior economist at National Bank Financial.
He said the bank, which he believes would like to keep the currency weaker to stoke demand for Canadian exports, could yet try to present the inflation jump as a temporary blip.
"I think they are going to keep spinning that story as long as they can, to keep the Canadian dollar from heading back towards parity," he said.
Retail sales data in April also boosted the currency, with auto sales leading the figure to its strongest gain in 11 months and pointing to a likely bounce in gross domestic product for the month.
The currency last traded at C$1.0759 to the U.S. dollar, or 92.95 U.S. cents, just off its strongest level of the session. It closed on Thursday at C$1.0823, or 92.40 U.S cents.
It briefly touched C$1.0752, its firmest level since Jan. 7.
Canadian government bond prices were sharply lower, with the two-year issue down 12 Canadian cents to yield 1.137 percent and the benchmark 10-year bond shedding 50 Canadian cents to yield 2.318 percent.
The yield on the two-year was at its highest since early January. (Editing by Jeffrey Hodgson; and Peter Galloway)