CANADA FX DEBT-C$ scores biggest gain in two months as economy grows

    * Canadian dollar rises 0.5 percent against the greenback
    * Canada's economy grows 0.2 percent in July
    * Bond prices trade mixed across a flatter yield curve
    * Canada-U.S. 2-year spread narrows by 2.6 basis points

    By Fergal Smith
    TORONTO, Sept 28 (Reuters) - The Canadian dollar notched its
largest gain in two months against the greenback on Friday after
data showing faster-than-expected growth of the domestic economy
boosted expectations of an interest rate hike from the Bank of
Canada in October.
    At 3:55 p.m. (1955 GMT), the Canadian dollar          was
trading 0.9 percent higher at 1.2923 to the greenback, or 77.38
U.S. cents, its biggest since July 20.
    It left the loonie as the best performing G10 currency on
Friday despite the expected release of the text of the Trump
administration's trade agreement with Mexico. For the week, the
Canadian dollar was nearly unchanged.
    U.S. President Donald Trump, who complained this week that
talks to modernize the North American Free Trade Agreement
(NAFTA) were moving too slowly, has threatened to leave Canada
out of the deal if it does not sign up by Sunday. He has also
proposed slapping auto tariffs on Canada.              
    "We have a lot of uncertainty on trade still," said Nathan
Janzen, a senior economist at Royal Bank of Canada. "At the same
time, the domestic economic backdrop still looks plenty strong
enough to warrant higher interest rates." 
    Canada's economy grew 0.2 percent in July, stronger than the
0.1 percent increase that analysts had forecast, Statistics
Canada data indicated.             
    The figures are significant because the Bank of Canada
earlier this month forecast that temporary factors would weigh
on third-quarter growth.
    Chances of an interest rate increase next month by the
central bank climbed to more than 80 percent from 77 percent
before the data, the overnight index swaps market indicated.
    The Bank of Canada will continue to raise interest rates
gradually, Governor Stephen Poloz said on Thursday.             
    The price of oil, one of Canada's major exports, rose as
U.S. sanctions on Tehran squeezed Iranian crude exports,
tightening supply even as other key exporters increased
    U.S. crude oil futures        settled 1.9 percent higher at
$73.46 a barrel.
    The U.S. dollar        climbed to a two-week peak versus a
currency basket as concerns about the Italian budget weighed on
the euro.                 
    Canadian government bond prices were mixed across a flatter
yield curve, with the two-year            down 2 Canadian cents
to yield 2.212 percent and the 10-year             rising 2
Canadian cents to yield 2.421 percent.
    The gap between the 2-year yield and its U.S. equivalent
narrowed by 2.8 basis points to a spread of 60.7 basis points in
favor of the U.S. bond.

 (Reporting by Fergal Smith; editing by Jonathan Oatis)