Canadian dollar weakens as GDP data supports Bank of Canada's caution

TORONTO (Reuters) - The Canadian dollar weakened against its U.S. counterpart on Tuesday after data showing a surprise contraction of the domestic economy supported the Bank of Canada’s caution on further interest rate hikes.

FILE PHOTO: An illustration picture shows Canadian banknotes of five Dollars in Reykjavik March 6, 2012. REUTERS/Ingolfur Juliusson

Canada’s gross domestic product declined 0.1 percent in August following flat growth in July, in part due to maintenance shutdowns in major industries. Analysts had forecast an increase of 0.1 percent.

“Any piece of data that would confirm the Bank of Canada’s caution would have an outsized effect on the currency,” said Eric Theoret, currency strategist at Scotiabank. “The Canadian dollar was vulnerable.”

Canada is at a “crucial” spot in the economic cycle with significant uncertainties clouding the way forward, Bank of Canada Governor Stephen Poloz said.

The central bank, which hiked rates in July and September for the first time in nearly seven years, left its benchmark rate unchanged at 1 percent last week.

At 4 p.m. EDT (2000 GMT), the Canadian dollar CAD=D4 was trading at C$1.2900 to the greenback, or 77.52 U.S. cents, down 0.5 percent.

The currency traded in a range of C$1.2825 to C$1.2915. On Friday, it touched its weakest in more than three months at C$1.2916.

In separate domestic data, producer prices fell by 0.3 percent in September from August as a stronger Canadian dollar helped cut prices for motorized and recreational vehicles.

Canada’s October employment report and trade data for September are due on Friday. The U.S. Federal Reserve will make an interest rate decision on Wednesday.

Prices of oil, one of Canada's major exports, added to recent gains. U.S. crude CLc1 prices settled up 0.4 percent at C$$54.38 a barrel. [O/R]

Canadian government bond prices were higher across the yield curve, with the two-year CA2YT=RR up 2.5 Canadian cents to yield 1.393 percent and the 10-year CA10YT=RR rising 6 Canadian cents to yield 1.951 percent.

Canadian yields fell further below yields on U.S. Treasuries across much of the curve.

The gap between Canada’s two-year yield and its U.S. counterpart widened by 3.2 basis points to a spread of -20.7 basis points, its widest since July 11.

Reporting by Fergal Smith, editing by G Crosse