March 4, 2008 / 1:17 PM / in 10 years

Canada dollar slumps on BoC rate cut, bonds mixed

TORONTO (Reuters) - The Canadian dollar tumbled lower against the U.S. dollar on Tuesday, after the Bank of Canada slashed its key interest rate and signaled more easing down the road.

Domestic bond prices rallied on the short end of the curve given the bank’s dovish tone.

The Canadian dollar closed at US$1.0049, valuing a U.S. dollar at 99.51 Canadian cents, down from US$1.0118, valuing a U.S. dollar at 98.83 Canadian cents, at Monday’s close.

It was the commodity-linked currency’s third straight losing session, handing back most of the gains it made last week when it rallied with rising oil, gold, wheat, and base metal prices.

The Bank of Canada cut its key rate by 50 basis points to 3.50 percent, the biggest cut since 2001. But that was not a surprise, as most primary dealers were expecting the aggressive move, according to a Reuters poll taken on Friday.

“It was maybe not so much the decision to cut 50, but the tone of the statement that sounded quite dovish and that more cuts were certainly on the horizon,” said Camilla Sutton, currency strategist at Scotia Capital.

The statement accompanying the announcement emphasized the downside risks to Canada’s economy due to the U.S. economic downturn, which it said was likely to be more prolonged than the central bank had projected in January.

As in January, the bank said further monetary stimulus is likely to be required, but this time, the bank left out any reference to the economy picking up in the later half of the year.

The Canadian dollar is now back in the range it had been in prior to last week, hovering near parity with the greenback.

“I think the same old story remains intact where it’s in this tug-of-war between the U.S. weakening economic outlook and the negative impact that has on Canada versus commodities, even though they’re off today, being generally very strong on historical levels,” said Sutton.

BONDS MIXED

Canadian bond prices moved higher on the short end of the curve in response to the Bank of Canada’s dovish tone.

“The additional movement in CBGs (Canadian government bonds) largely stemmed from the fact that new governor Carney said that further monetary stimulus would likely be required in the near term,” said Max Clarke, economist at IDEAglobal in New York.

The question many in the market are now asking is, how big will the next cut be?

The Bank of Canada tended to take a gradual approach in setting monetary policy under previous Governor David Dodge, but with a 50 basis-point cut in Carney’s first decision as governor, the door is now wide open.

“There is a new Captain of the ship and things might be changing,” said Clarke, who said the market was pricing in a 20 percent chance that the central bank will cut by 75 basis points when it next sets policy.

The two-year bond was up 6 Canadian cents at C$102.64 to yield 2.683 percent. The 10-year bond slipped 9 Canadian cents to C$102.89 to yield 3.628 percent.

The yield spread between the two- and 10-year bond was 94.5 basis points, up from 90.2 points at the previous close.

The 30-year bond dropped 55 Canadian cents to C$115.00 to yield 4.113 percent. In the United States, the 30-year Treasury yielded 4.504 percent.

The three-month when-issued T-bill yielded 2.90 percent, down from 2.98 percent at the previous close.

Editing by Renato Andrade

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