UPDATE 3-C$ weakens from 2 1/2 year high on dovish BoC

Tue Jan 18, 2011 5:02pm EST
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   * C$ ends session at C$0.9929, or $1.0072
 * Bank of Canada holds rate steady at 1 percent
 * Short-term yields fall after Bank of Canada statement
 (Updates with details, comments)
 By Solarina Ho
 TORONTO, Jan 18 (Reuters) - Canada's dollar fell from a 2
1/2-year high against the U.S. currency on Tuesday to close
weaker after the central bank used more dovish-than-expected
language in its much anticipated interest rate decision.
 The Bank of Canada held its overnight lending target steady
at 1 percent, as most traders expected, for the third straight
time after raising rates three times between June and September
2010. [ID:nN18290983]
 But it toughened its language on the harmful effects of the
strong Canadian dollar on the recovery, noting the currency
helped drive the current account deficit to a 20-year high.
 "They're giving bulls nothing to dance about," said John
Curran, senior vice president at CanadianForex.
 "While they have revised growth slightly higher,
realistically, the level of the Canadian dollar where we are
right now -- that's having a drag."
 The central bank said persistent strength in the Canadian
dollar, combined with poor relative productivity, was
restraining a recovery in exports.
 The Canadian dollar CAD=D4 finished weaker, at C$0.9929
to the U.S. dollar, or $1.0072. It closed at C$0.9872, or
$1.0130 on Monday.
 Overnight, it hit a 2-1/2 year high of C$0.9837 against the
U.S. dollar, with some traders betting on more hawkish language
in the statement.
 "It was less hawkish than a lot of people were expecting,"
said Jacqui Douglas, currency strategist at TD Securities.
 "It seems like markets may be getting a little
uncomfortable with how low USD/CAD has been heading and may
want to rethink that value for the Canadian dollar now that the
Bank of Canada looks like it's on hold for a while still."
 The Bank of Canada nudged up economic growth forecasts for
2011 and 2012 to reflect the strength of the global economic
recovery, but said that further reductions in monetary policy
stimulus would need to be carefully considered.
 At least one of Canada's primary dealers pushed back its
rate hike forecast from March, though most still see a rate
hike in the first half, according to a Reuters poll. [CA/POLL]
 Overnight index swaps, which trade based on expectations
for the key central bank rate, showed investors see an 84.36
percent probability rates will stay on hold March 1, compared
with 72.85 percent before the statement. BOCWATCH
 The Canadian government took steps on Monday to curb credit
growth, tightening its mortgage rules and reducing support for
lines of credit secured by homes. [ID:nN17274705]
 Analysts will next analyze the the bank's Monetary Policy
Report due out on Wednesday for further guidance.
 Canadian government T-bill and bond yields fell immediately
after the rate announcement, reflecting a scaling back of rate
hike expectations.
 But most bond prices later fell, with long-dated bonds
mirroring weakness in U.S. Treasury prices. U.S. Treasury
prices fell on Tuesday in a market traders said took its tone
in part from hedging operations at the start of a heavy week of
corporate bond issuance. [US/]
 The yield on the rate-sensitive two-year Canadian
government bond CA2YT=RR was at 1.768 percent, down from the
1.792 percent just before the statement. The 10-year bond was
down 19 Canadian cents to yield 3.28 percent. <0#CABMK=>
 (Editing by Jeffrey Hodgson)