* Ends at C$1.0173 to the US$, or 98.30 U.S. cents
* Touches 98.48 U.S. cents, highest level since Aug. 6
* US$ slides on belief Fed will ease monetary policy
* Bond prices flat to lower (Updates to close, adds quote)
By Jennifer Kwan
TORONTO, Oct 5 (Reuters) - Canada's dollar rallied to a two-month high on Tuesday as the greenback slid on speculation the U.S. Federal Reserve would further ease monetary policy, following a similar move by the Bank of Japan.
The Bank of Japan on Tuesday pledged to pump more funds into the struggling economy and keep rates almost at zero in a surprise move that helped to send commodity and equity markets sharply higher. [MKTS/GLOB] [ID:nTOE69305D]
"What you're seeing here is the central bank going back and buying assets in the market directly, and this has a way of filtering out through other markets," said Larry Kantor, head of research at Barclays Capital.
"It's sort of like a giant investor coming in with incredible deep pockets, and can buy unlimited quantities of stuff."
The move added to the growing belief that the Fed will ease monetary policy further, which helped to send the greenback lower on Tuesday. [FRX/]
The key catalyst stoking expectations of U.S. quantitative easing came last week when William Dudley, president of the Federal Reserve of New York, said action to boost growth will likely be warranted unless the economic outlook improves. [ID:nNLL1LE6II]
"It's very unlikely that the president of the New York Fed is going to make such strong comments supporting further quantitative easing unless they're really going to do it," said Kantor. "It was his comments that made the difference here."
The Canadian currency CAD=D4 ended at C$1.0173 to the U.S. dollar, or 98.30 U.S. cents, after rising as high as C$1.0154, or 98.48 U.S. cents, its highest level since Aug. 6. On Monday, the currency closed at C$1.0220 to the U.S. dollar, or 97.85 U.S. cents.
The sliding greenback helped to lift the price of oil CLc1, a key Canadian export, which rose toward $83 a barrel, while gold prices XAU= touched a record above $1,340 an ounce. [O/R] [GOL/]
Firas Askari, head of foreign exchange trading at BMO Capital Markets, said a key short-term support level strategists will be watching is around C$1.0108-C$1.010 to the U.S. dollar.
BONDS FLAT TO LOWER
Canadian government bond prices were largely flat to lower on strength in equity markets. U.S. stocks rallied on Tuesday, pushing the S&P index to its highest level since mid-May as investors cheered encouraging economic data and new credit easing steps by the Bank of Japan. [.N] Toronto stocks closed at a two-year high. [.TO]
Bank of Canada Deputy Governor Tiff Macklem said Canada's optimal inflation rate may be lower than the current 2 percent target, but the existing system has worked so well the central bank should be cautious about changing it. [.N]
His remarks did not give any hints on the outlook for the currency or monetary policy, and had almost no market effect, said BMO's Askari.
Markets were pricing in a 90.9 percent probability the Bank of Canada would hold rates steady in October, according to Reuters' calculation based on overnight index swaps, which trade based on expectations for the central bank's policy rate. BOCWATCH
The two-year bond CA2YT=RR was unchanged to yield 1.362 percent, while the 10-year bond CA10YT=RR ticked 11 Canadian cents lower to yield 2.765 percent. (Editing by Peter Galloway)