TORONTO (Reuters) - The Canadian dollar shot to its highest level in more than two months versus the U.S. dollar on Wednesday as domestic inflation data came in ahead of estimates and forced the market to reconsider whether the Bank of Canada will need to reduce interest rates further.
Domestic bond prices held positive shortly after the data but eventually all turned lower across the curve as the data supported calls for fewer, if any, Bank of Canada rate cuts.
At 8:40 a.m. EDT, the Canadian currency was at US$1.0150, valuing a U.S. dollar at 98.52 Canadian cents, up from US$1.0082, valuing a U.S. dollar at 99.18 Canadian cents, at Tuesday's close.
The latest rise in the domestic currency came immediately after data showed annual inflation in Canada beat expectations in April, rising to 1.7 percent on gasoline price hikes.
The currency rose to US$1.0184, valuing a U.S. dollar at 98.19 U.S. cents, right after the data, from a pre-data level around US$1.0138, valuing a U.S. dollar at 98.64 Canadian cents.
"The Canadian dollar strengthened substantially and it all circles back around to this report and the monetary policy implications that stem from it," said Eric Lascelles, chief economics and rates strategist at TD Securities.
"In terms of the implications for the Bank of Canada I would say it certainly strikes a blow against the argument for a 50-basis-point cut and probably in favor of a 25-basis-point cut."
The Bank of Canada's next rate announcement is June 10 and a Reuters poll taken last month showed expectations of Canadian primary dealers ranged from an interest rate cut of 25 basis points to a 50 basis point cut.
The central bank's overnight rate is 3.00 percent following a string of rate cuts that have shaved 150 basis points from the key rate since December.
The commodity-linked Canadian dollar, now well positioned for its third straight winning week, has also been supported by lofty oil prices. U.S. crude prices hit an all-time high above $130 a barrel on Wednesday.
Canada is a major oil exporter and the direction of its currency is often influenced by prices for the commodity.
Canadian bond prices were sharply lower as the inflation data ate away at early gains and left prices pinned lower across the curve.
Lascelles blamed the sharp turnaround in bond prices on the data that showed the consumer price index rose 0.8 percent in April, which marked its biggest rise in 13 months, for an annual rate of 1.7 percent, the first acceleration in five months.
A report that showed Canada's composite leading indicator climbed 0.1 percent in April as expected did not appear to have much impact on bond prices.
The only remaining Canadian data due this week are the retail trade data for March on Thursday.
Bank of Canada Governor Mark Carney is also scheduled to give a speech on "Principles for Liquid Markets" in New York on Thursday to the New York Association for Business Economics. His speech will be followed by a news conference.
The two-year bond was down 27 Canadian cents at C$101.66 to yield 2.900 percent. The 10-year was off 65 Canadian cents at C$103.05 to yield 3.601 percent.
The yield spread between the two- and 10-year bonds was 70.1 basis points, down from 75.0 at the previous close.
The 30-year bond dropped 63 Canadian cents to C$115.97 for a yield of 4.058 percent. In the United States, the 30-year Treasury yielded 4.555 percent.
The three-month when-issued T-bill yielded 2.66 percent, up from 2.62 percent at the previous close.
Editing by Renato Andrade