June 9, 2008 / 2:01 PM / in 9 years

Dollar drops ahead of rate decision

TORONTO (Reuters) - The Canadian dollar ended lower versus the U.S. dollar on Monday as the market took profits before what is widely expected to an interest rate cut by the Bank of Canada on Tuesday.

Canadian bond prices were knocked lower across the curve as expectations for more rate hikes in Europe weighed on sentiment in Canada and curbed the appetite for secure assets.

The Canadian dollar closed at C$1.0216 to the U.S. dollar, or 97.89 U.S. cents, down from C$1.0193 to the U.S. dollar, or 98.11 U.S. cents, at Friday’s close.

The Bank of Canada will announce an interest-rate decision on Tuesday, and a recent Reuters poll showed all 12 Canadian primary dealers expect the bank to lower its key overnight rate by 25 basis points to 2.75 percent.

Focus will be on the bank’s accompanying statement to see if it offers any hint on where its key rate is headed since recent data have showed Canada’s gross domestic product shrank unexpectedly in the first quarter.

“A lot of people are focused on tomorrow’s Bank of Canada rate-setting meeting and just how the Bank of Canada is going to lay the groundwork for the future given some of the hawkish rhetoric coming out of a number of central banks,” said David Watt, senior currency strategist at RBC Capital Markets.

“People are wondering whether the Bank of Canada is going to leave the door open to future rate cuts given the negative first-quarter GDP number we had.”

The Bank of Canada has cut its key rate by 150 basis points since the start of December, but the Canada-U.S. interest-rate gap still favors the Canadian dollar and has helped keep it near par versus its U.S. counterpart.

Also weighing on the Canadian currency were comments from U.S. Treasury Secretary Henry Paulson, who declined to rule out intervening in currency markets to stabilize the U.S. dollar. His comments gave a bid to the U.S. dollar, which added to the slide in the Canadian dollar.

Figures released early in the session showed Canadian housing starts rose in May by more than analysts had expected. The data did not have much impact on the Canadian dollar, however.

BOND PRICES FALL

Canadian bond prices followed the U.S. Treasury market to a lower close and gave back a portion of big gains made at the end of last week as the European Central Bank said interest rates in the euro zone could rise as soon as next week.

But the size of the selloff was considered overdone by some since Canada is so far removed from the concerns that sparked the selling.

“Right now it’s expectations of inflation and rate hikes in Europe ... and the U.S. (Treasury market) is responding to that and it’s filtering into Canada,” said Eric Lascelles, chief economics and rates strategist at TD Securities. “I think the magnitude of the selloff is overblown on both sides of the North American border.”

Lascelles said the size of the selloff in bond prices could make for a muted reaction on Tuesday if the statement from the Bank of Canada does deliver a dovish tone to the market.

The two-year bond fell 40 Canadian cents to C$101.28 to yield 3.076 percent. The 10-year bond dropped 50 Canadian cents to C$102.17 to yield 3.713 percent.

The yield spread between the two-year and 10-year bond was 63.2 basis points, down from 77.9 at the previous close.

The 30-year bond eased 16 Canadian cents to C$114.79 for a yield of 4.121 percent. In the United States, the 30-year Treasury yielded 4.638 percent.

The three-month when-issued T-bill yielded 2.56 percent, up from 2.55 percent at the previous close.

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