September 3, 2008 / 8:28 PM / in 9 years

Dollar rallies as BoC holds rates steady

TORONTO (Reuters) - The Canadian dollar reversed early losses to finish higher against the U.S. dollar on Wednesday, after the Bank of Canada held its key interest rate steady and gave no sign it would ease any time this year.

Shorter-dated bonds fell after the bank’s announcement, as the market began pricing out an expected rate cut.

The Canadian dollar ended the North American session at C$1.0610 to the U.S. dollar, or 94.25 U.S. cents, up from C$1.0686 to the U.S. dollar, or 93.58 U.S. cents, at Tuesday’s close.

The currency fell as low as C$1.0777 to the U.S. dollar, or 92.79 U.S. cents, early in the session, but surged higher after the central bank left its key rate steady at 3 percent and delivered a statement that lessened the odds for a rate cut at its next decision.

“The bank firmly reiterated its neutral stance,” said Matthew Strauss, senior currency strategist at RBC Capital Markets. “So the market had to price out the possibility of a cut before the year and consequently we had that very strong rally in the Canadian dollar.”

Most Canadian primary securities dealers did not think the bank would alter its key lending rate, but expected it to signal a bias towards easing.

Instead, the bank said the current level of the target for the overnight rate “remains appropriately accommodative.”

The bank has lowered the overnight rate by 150 basis points since late last year in an attempt to spur growth in light of the U.S. economic slowdown.

The Canadian dollar has been under pressure in recent weeks as the price of U.S. crude oil fell to below $110 a barrel from a high of $147.27 in mid-July. Canada is a major oil exporter to the United States.

The next event with the potential to rattle the currency comes Friday with the release of the August employment report.

In July, Canada’s faltering economy shed 55,000 jobs, the biggest monthly toll since the recession in 1991. The Canadian dollar lost 1.3 percent the day the data was released.

BOND PRICES MIXED

Shorter-dated bonds were knocked lower after the Bank of Canada statement failed to signal any imminent interest rate cuts.

“The front end was pricing in a the possibility of a rate cut in October and they’ve removed some of that,” said Sheldon Dong, fixed income analyst at TD Waterhouse Private Investment.

“At the same time, the commodity crashes are lowering inflation expectations, so that gives a reason for the long-end to rally.”

The two-year bond fell 12 Canadian cents to C$110.07 to yield 2.717 percent, while the 10-year added 6 Canadian cents to C$106.31 to yield 3.479 percent.

The yield spread between the two-year and 10-year bond was 75.1 basis points, down from 85.9 basis points at the previous close.

The 30-year bond gained 6 Canadian cents to C$117.21 for a yield of 3.988 percent. In the United States, the 30-year treasury yielded 4.321 percent.

The three-month when-issued T-bill yielded 2.48 percent, up from 2.43 percent at the previous close.

Reporting by John McCrank

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