TORONTO (Reuters) - The Canadian dollar skidded to its lowest close in more than three years versus the U.S. dollar on Tuesday as the Bank of Canada cut its key overnight interest rate and suggested more rate cuts may be needed.
Bond prices finished comfortably higher across the curve as the likelihood of further Bank of Canada rate cuts and a slide in equity markets sparked another wave of demand for secure government debt.
The Canadian dollar closed at C$1.2137 to the U.S. dollar, or 82.39 U.S. cents, down from C$1.1937 to the U.S. dollar, or 83.77 U.S. cents, at Monday's close.
The Bank of Canada's decision to lower its key rate by 25 basis points fell short of the 50-basis-point cut that many of Canada's primary securities dealers had expected, but the tone of the statement was enough to keep the Canadian dollar down.
Not only did the central bank suggest it would likely cut rates further, but it also slashed its projections for economic growth and inflation given the global economic downturn, financial markets in stress, and the fall in commodity prices.
"It looks like rates will be going lower in Canada and that's not good for the (Canadian) currency," said Charmaine Buskas, senior economics strategist at TD Securities.
"The Canadian dollar has also been hit by softening oil prices so that kind of one-two punch didn't really provide much in the way of support for the (currency) today."
Lower oil prices often weigh on the Canadian dollar because Canada is a key supplier of oil to the United States.
The rate cut follows the Bank of Canada's unexpected 50-basis-point cut on October 8 in a coordinated move with other central banks to help calm ailing financial markets. The bank's key rate is now 2.25 percent.
The Canadian dollar got a short-lived boost to C$1.2023 to the U.S. dollar, or 83.17 U.S. cents, immediately after the rate announcement since it was less than the 50-point cut many had been anticipating.
But the gain was quickly wiped out as the market started to sift through the details of the bank's statement. The Bank of Canada will offer more details on its projection for the economy and inflation when it releases its Monetary Policy Report on October 23.
"What the market is really keying in on is the overt dovish sentiment that's been delivered in the communique," said Jack Spitz, managing director of foreign exchange at National Bank of Canada.
"Nothing about the communique that I can see suggests that the bank is looking at anything other than potentially cutting rates going forward."
Canadian bond prices all finished higher due to a sharp selloff in equities and the likelihood of more rate cuts in Canada.
After big gains for Toronto Stock Exchange's main index on Friday and Monday, investors returned to their selling ways on Tuesday as the market fell 455 points, or 4.4 percent.
Bond prices hovered around the break-even level early in the morning but eventually moved higher across the curve after the Bank of Canada cut its overnight lending rate to its lowest level since September 2004.
"Some of the optimism we had seen on Friday and Monday is perhaps reversing and so money is flowing back into bonds," said Carlos Leitao, chief economist at Laurentian Bank of Canada. "And while today's rate cut was generally what was expected, people were expecting something a little more."
The two-year bond rose 5 Canadian cents to C$101.19 to yield 2.169 percent. The 10-year bond increased 21 Canadian cents to C$104.48 to yield 3.691 percent.
The yield spread between the two-year and the 10-year bond moved to 154 basis points from 157 basis points at the previous close.
The 30-year bond rose 71 Canadian cents to C$113.56 to yield 4.182 percent. In the United States, the 30-year Treasury yielded 4.212 percent.
Editing by Peter Galloway