CANADA FX DEBT-C$ hits 2-month low as retail sales fall

    * Canadian dollar at C$1.2721, or 78.61 U.S. cents
    * Loonie touches its weakest since Dec. 22 at C$1.2760
    * Bond prices rise across the yield curve
    * 2-year spread touches its widest since June 12

    By Fergal Smith
    TORONTO, Feb 22 (Reuters) - The Canadian dollar weakened to
a two-month low against its U.S. counterpart on Thursday after a
surprise drop in domestic retail sales dented prospects for
further Bank of Canada interest rate hikes over the coming
    Canadian retail sales decreased by 0.8 percent in December
from November as sales fell at general merchandise stores and
electronics and appliance stores, Statistics Canada said.
Analysts had forecast an increase of 0.2 percent.             
    It followed recent data that showed manufacturing sales and
wholesale trade also dropped in December.
    "All told, a reason to keep the C$ trading weak, with work
still to be done in pricing out the spring tightening bias
expected from the BoC," Nick Exarhos, an economist at CIBC
Capital Markets, said in a research note.
    Chances of another Bank of Canada interest rate hike in May
fell to 77 percent from 86 percent before the retail sales
report, data from the overnight index swaps market showed.
    The central bank raised interest rates in January for the
third time since July. Its benchmark rate sits at 1.25 percent.
    At 9:06 a.m. EST (1406 GMT), the Canadian dollar         
was trading 0.1 percent lower at C$1.2721 to the greenback, or
78.61 U.S. cents.
    The currency's strongest level of the session was C$1.2677,
while it touched its weakest since Dec. 22 at C$1.2760.
    The price of oil, one of Canada's major exports, was
supported by a surprise decline in U.S. crude inventories.
    U.S. crude        prices were up 0.55 percent to $62.02 a
    Canadian government bond prices were higher across the yield
curve, with the two-year            price up 12 Canadian cents
to yield 1.787 percent and the 10-year             rising 52
Canadian cents to yield 2.289 percent.
    The gap between Canada's 2-year yield and its U.S.
equivalent widened by 5.3 basis points to a spread of -47.5
basis points, its widest since June 12.
    It follows the release on Wednesday of minutes of the latest
Federal Reserve meeting, which affirmed expectations of further
rate increases this year.             
    Canada's inflation report for January is due on Friday.   

 (Reporting by Fergal Smith; Editing by Jonathan Oatis)