July 23, 2008 / 9:42 PM / in 9 years

Canadian dollar falls on oil, rate uncertainty

<p>A Canadian one dollar coin, also know as a loonie, is shown in Montreal in this April 28, 2006 file photo. REUTERS/Shaun Best</p>

TORONTO (Reuters) - The Canadian dollar fell to its lowest close in two weeks against a rallying U.S. dollar on Wednesday, despite a report that showed inflation in Canada was higher than the market had forecast, hurt by falling oil prices and an uncertain outlook for Canadian interest rates.

Bond prices ended mostly lower, taking direction from the larger U.S. market.

The Canadian currency closed at C$1.0103 to the U.S. dollar, or 98.98 U.S. cents, down from C$1.0084 to the U.S. dollar, or 99.17 U.S. cents, at Tuesday’s close.

The currency has slid 1 percent since Monday, hurt by soft economic data and falling oil prices.

Retail sales data on Tuesday showed domestic spending in Canada was starting to sink. Domestic demand had been helping keep the economy afloat as other sectors of the economy were engulfed by the economic storm blowing in from the United States.

Meanwhile, the price of U.S. crude oil has slid to a six-week low on concerns that high energy prices would further weaken the U.S. economy and slash demand.

Canada, which has the largest reserves of oil outside the Middle East, is the top supplier of crude to the United States. The huge run up in oil prices has been credited as a major reason for the Canadian dollar’s 60 percent appreciation since 2002.

Data on Wednesday showed the headline inflation rate rose past expectations to 3.1 percent in June from 2.2 percent in May.

That initially drove the Canadian dollar higher, as investors thought the Bank of Canada might have to raise interest rates to get inflation under control.

But the rally was brief as the data showed core inflation, which strips out volatile food and energy prices, stood at 1.5 percent, comfortably below the central bank’s 2 percent target, giving the bank room to cut rates if risks to economic growth begin to outweigh risks from high inflation.

“The core is telling the Bank of Canada they can ease (interest rates) if they have to ease and if things start to deteriorate more, and we see a negative GDP reading,” said Steve Butler, director of foreign exchange at Scotia Capital.

“Don’t expect the Bank of Canada to be hawkish like we saw in the comments from Mr. Plosser, from the Fed, talking about rates going up in the States.”

Philadelphia Federal Reserve President Charles Plosser said on Tuesday the U.S. central bank may have to raise interest rates sooner rather than later to combat inflation.

That caused U.S. interest rate futures to climb sharply and sparked a rally in the greenback.

BONDS MOSTLY LOWER

Canadian bond prices ended mixed, taking some direction from the Canadian inflation report, but mainly tracking the larger U.S. market, which fell as a solid performance for U.S. stocks reduced the safety bid for government debt.

“There’s definitely no smoking gun in the inflation report,” said Mark Chandler, fixed income strategist at RBC Capital Markets.

He said investors were unsure of how to interpret the effect of the report on the central bank as the headline number was a strong one, but the bank had warned last week in its Monetary Policy Report Update that it expected inflation to rise, but that it would be temporary.

The two-year bond fell 1 Canadian cent to C$100.95 to yield 3.218 percent. The 10-year bond fell 2 Canadian cents to C$103.25 to yield 3.849 percent.

The yield spread between the two-year and 10-year bond was 63.1 basis points, down from 63.7 basis points.

The 30-year bond rose 11 Canadian cents to C$113.96 for a yield of 4.164 percent. In the United States, the 30-year treasury yielded 4.679 percent.

The three-month when-issued T-bill yielded 2.48 percent, up from 2.45 percent from the previous close.

Editing by Peter Galloway

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