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* Canada dollar rises 0.7 pct on U.S. dollar weakness
* Canada inflation rises, but on low side of expectations
* Bonds helped by higher C$ and lower inflation concerns
By John McCrank
TORONTO, Aug 21 (Reuters) - The Canadian dollar rose 0.7 percent against a besieged U.S. dollar on Thursday, as worries over the state of the U.S. financial sector triggered a sell-off in the greenback, and gave a boost to commodity prices.
Bond prices rose on the back of the U.S. financials, mostly ignoring Canadian inflation data, which came in on the low-end of market expectations.
At 8:50 a.m. (1250 GMT), the Canadian dollar was at C$1.0540 to the U.S. dollar, or 94.88 U.S. cents, up from C$1.0612 to the U.S. dollar, or 94.23 U.S. cents, at Wednesday's close.
The currency steadily climbed against its U.S. counterpart from midway through Wednesday's North American session, as the market focused on worries about U.S. mortgage finance giants Fannie Mae FNM.N and Freddie Mac FRE.N. See [ID:nN21288958]
Those concerns grew overnight with a report from the Wall Street Journal that said the U.S. Federal Reserve had investigated investment bank Lehman Brothers LEH.N regarding rumors over its credit line. See [ID:nBNG249402]
"It seems to have started a wave of concern on the financial sector generally and that's hitting (equities) and that's hitting the dollar," said Adam Cole, head currency strategist at RBC Capital Markets in London.
Commodity prices rose on the back of the U.S. dollar weakness. U.S. crude oil prices CLc1 were given an extra boost from geopolitical tensions between the U.S. and Russia, the world's second largest oil producer. See [ID:nSP213151]
Canada is the largest exporter of oil to the United States, and its currency often takes directions from moves in the price of the commodity.
On the data front, one of the most anticipated reports for the month went largely unnoticed.
Canada's annual inflation rate quickened to 3.4 percent in July from 3.1 percent in June, on soaring gasoline prices. See [ID:nN21407059]
But the upswing was largely expected and did little to change the view that the Bank of Canada will keep interest rates on hold in September.
The core rate, which strips out volatile food and energy prices, came in at 1.5 percent, versus expectations of 1.6 percent.
"The core measure of CPI was a little lower than expected, and I would have normally expected that to be a negative for the Canadian dollar, but we are generally seeing the (U.S.) dollar lower across the board and commodity prices higher," said Cole.
"I guess those two impacts are outweighing at the moment."
Domestic bond prices were flat to higher, keying off the stronger Canadian dollar and the slightly weaker-than-expected core inflation data.
"Both of those developments are supportive of the Canadian bond market and underlying the outperformance of (U.S.) treasuries," said Sal Guatieri, senior economist at BMO Capital Markets.
The overnight Canadian Libor rate LIBOR01 was 2.9500 percent, down from 2.9550 percent on Wednesday.
The two-year bond was flat at C$101.65 to yield 2.784 percent. The 10-year bond rose 13 Canadian cents to C$105.63 to yield 3.561 percent.
The yield spread between the two-year and 10-year bond was 78.8 basis points, up from 77.8 at the previous close.
The 30-year bond added 11 Canadian cents to C$116.36 for a yield of 4.034 percent. In the United States, the 30-year treasury yielded 4.448 percent.
The three-month when-issued T-bill yielded 2.49 percent, down from 2.52 percent at the previous close. (Editing by Scott Anderson)