C$ pares its gains as oil prices slump, Fed hikes

TORONTO (Reuters) - The Canadian dollar edged higher on Wednesday against its U.S. counterpart but pulled back from a 3-1/2-month high as oil prices fell sharply and the Federal Reserve raised interest rates.

FILE PHOTO: A Canadian dollar coin, commonly known as the "Loonie", is pictured in this illustration picture taken in Toronto January 23, 2015. REUTERS/Mark Blinch/File Photo

The loonie has soared this week after the Bank of Canada signaled higher interest rates ahead.

Investors have moved forward their expectations for when the central bank will begin raising rates, said Hosen Marjaee, senior managing director, Canadian fixed income at Manulife Asset Management.

Chances of a rate hike this year have surged to 87 percent from less than one-in-four before stronger-than-expected jobs data on Friday.

Canadian household debt as a share of income dipped to 166.9 percent in the first quarter but remained near record highs, while separate domestic data showed that home prices rose in May.

Canada’s central bank, which had long said interest rates are too blunt a tool to tackle the country’s housing market, may have finally decided to act and at least limit its role in fueling a potential bubble with low interest rates.

The U.S. dollar .DXY had been pressured by weaker-than-expected economic data but reversed most of its losses against a basket of major currencies after the Fed raised rates and said it was prepared to continue tightening monetary policy.

Crude oil prices slumped to their lowest close in seven months on Wednesday, hit by an unexpected large build in gasoline inventories. U.S. crude oil futures CLc1 settled $1.73 lower at $44.73 a barrel.

At 4 p.m. EDT (2000 GMT), the Canadian dollar CAD=D4 was trading at C$1.3234 to the greenback, or 75.56 U.S. cents, up 0.1 percent.

The currency’s weakest level of the session was C$1.3271, while it touched its strongest since Feb. 28 at C$1.3165.

Canadian government bond prices were higher across the yield curve in sympathy with U.S. Treasuries. The two-year CA2YT=RR rose 4 Canadian cents to yield 0.887 percent and the 10-year CA10YT=RR climbed 51 Canadian cents to yield 1.505 percent.

The gap between the 10-year yield and its U.S. equivalent narrowed by 0.9 of a basis points to a spread of -63.7 basis points, its smallest since Nov. 8, the day of the U.S. election.

Spreads between Canada and the U.S. could narrow further as Canada’s economy builds momentum in the first half of the year and as the U.S. economy shows some signs of slowing, Marjaee said. “Our portfolio strategy is to benefit from that.”

Reporting by Fergal Smith; Editing by Meredith Mazzilli and David Gregorio