TORONTO (Reuters) - The Canadian dollar fell 0.7 percent against the U.S. dollar on Tuesday on weaker-than-expected retail sales data for May and a widespread rally in the greenback against major currencies.
Canadian bond prices rose initially, but later followed the U.S. fixed income market lower after hawkish inflation comments from a U.S. Federal Reserve member and a rebound in U.S equities.
The Canadian dollar closed at C$1.0084 to the U.S. dollar, or 99.17 U.S. cents, down from C$1.0014 to the U.S. dollar, or 99.86 U.S. cents, at Monday's close.
The currency hovered near parity for much of the overseas session, but then dropped to C$1.0062 shortly after the May retail sales numbers were released, and fell steadily for most of the morning.
Statistics Canada said soaring gasoline prices drove sales up by 0.4 percent from April, but excluding price changes, sales rose just 0.1 percent. Excluding autos, sales rose by 0.4 percent.
Analysts surveyed by Reuters had expected a 0.6 percent rise in overall retail sales, and a 0.8 percent increase excluding auto sales.
"No disaster, but it was a pretty soft number and certainly not near the expectations, so there was a bit of a liquidation move on the back of that," said Shaun Osborne, chief currency strategist at TD Securities.
"This morning's disappointing retail sales data reinforce the view that the Canadian consumer is fading somewhat as higher headline inflation saps real spending power," Merrill Lynch Canada economist David Wolf said in a research note.
Aside from the sales data, the U.S. dollar was rallying against major currencies such as the euro, Osborne noted. Remarks by Treasury and Fed officials were interpreted as supporting the U.S. currency.
Statistics Canada will release June inflation data on Wednesday, but market observers said the central bank has already braced traders for what could be a high reading.
In its Monetary Policy Report update last week, the Bank of Canada said soaring oil prices would lift headline inflation as high as 4.3 percent in early 2009, while core inflation, which strips out volatile food and energy prices, should stay within the bank's 1 percent to 3 percent target range.
With the U.S. dollar pushing through C$1.010 during Tuesday's session, "it really does look as if the Canadian dollar may soften up a little bit more," Osborne said.
The Bank of Canada has strongly hinted that interest rates are on hold "so I think it's going to take a very strong (inflation) number to lift the Canadian dollar substantially from here," Osborne added.
Bond prices initially rose after the Canadian retail sales numbers, but then reversed course and slipped lower across the yield curve with the U.S. market.
Philadelphia Federal Reserve Bank President Charles Plosser said on Tuesday that rising inflation could force the Fed to start raising interest rates sooner rather than later, while lower oil prices boosted U.S. stocks late in the session, overshadowing financial sector concerns.
"That took some of the bid out of the fixed-income markets, out of the sovereign markets," said Stewart Hall, market strategist at HSBC Canada.
As for Wednesday's CPI report, the Bank of Canada has taken away some potential "shock value" in the numbers, Hall noted.
"Everyone seems to be on the same page, that you're going to get a 3 percent print, maybe 3-percent-plus, on the headline inflation rate," Hall said.
The two-year bond dipped 9 Canadian cents to C$100.96 to yield 3.210 percent. The 10-year bond fell 33 Canadian cents to C$103.27 to yield 3.847 percent.
The yield spread between the two-year and 10-year bond was 63.7 basis points, up from 64.4 basis points.
The 30-year bond fell 36 Canadian cents to C$113.95 for a yield of 4.165 percent. In the United States, the 30-year treasury yielded 4.672 percent.
The three-month when-issued T-bill yielded 2.45 percent, up from 2.37 percent from the previous close.
Editing by Peter Galloway