UPDATE 3-C$ weakens from 2 1/2 year high on dovish BoC
* 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.
SHORT-TERM YIELDS FALL
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)
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