CANADA FX DEBT-C$ gains as data boosts chances of October rate hike

    * Canadian dollar at C$1.2556, or 79.64 U.S. cents
    * Domestic retail sales rise more than expected in May
    * Chances rise of a second interest rate hike in October
    * Bond prices mixed across the yield curve

    By Fergal Smith
    TORONTO, July 21 (Reuters) - The Canadian dollar
strengthened against its U.S. counterpart on Friday, boosted by
stronger-than-expected retail sales data that supported
prospects for another interest rate increase by the Bank of
    Retail sales rose by 0.6 percent in May from April to hit a
record C$48.91 billion, Statistics Canada said, much greater
than the 0.2 percent advance forecast by analysts in a Reuters
poll. Sales volumes grew by 1.1 percent.
    A separate report showed Canada's annual inflation rate
slowed to a 20-month low of 1.0 percent in June, well below the
Bank of Canada's 2.0 percent target, although core measures
showed signs of strength.                         
    "The Bank of Canada can be expected to pursue that
normalization (in rates) it started in July," said Jimmy Jean,
senior economist at Desjardins.
    The central bank raised interest rates last week for the
first time since 2010. Chances of a second rate hike in October
climbed above 70 percent from a roughly two-thirds chance before
the economic reports, data from the overnight index swaps market
    Still, Canada's real return bonds and flat yield curve are
signaling the Bank of Canada will not reach its 2 percent
inflation target any time soon. That suggests the central bank
is unlikely to pull off more than one more rate hike even as
money markets see further tightening into 2018.             
    At 9:21 a.m. ET (1321 GMT), the Canadian dollar          was
trading at C$1.2556 to the greenback, or 79.64 U.S. cents, up
0.3 percent.
    The currency traded in a range of C$1.2546 to C$1.2607. On
Thursday, it touched its strongest since early May 2016 at
    The loonie rose even as prices of oil, one of Canada's major
exports, fell after a consultancy report forecast a rise in OPEC
production for July.             
    U.S. crude        prices were down 0.60 percent at $46.64 a
    Canadian government bond prices were mixed across the yield
curve, with the two-year            down 0.5 Canadian cent to
yield 1.245 percent and the 10-year             climbing 4
Canadian cents to yield 1.878 percent.
    The gap between the 2-year yield and its U.S. equivalent
narrowed by 1.1 basis points to a spread of -10.8 basis points,
its narrowest since early July 2016.   

 (Editing by Bernadette Baum)