* Canadian dollar adds to last week's 0.9 percent gain
* Bank of Canada Business Outlook Survey sparks rally
* Canada's May building permits rise unexpectedly
By Frank Pingue
TORONTO, July 7 (Reuters) - The Canadian dollar rebounded to finish higher versus the U.S. dollar on Monday after the Bank of Canada Business Outlook Survey seemed to point to increased inflationary risks and spurred talk of interest rate hikes.
Canadian bond prices ended higher across the curve as stock markets fell, sparking demand for government debt.
The Canadian dollar closed at C$1.0189 to the U.S. dollar, or 98.15 U.S. cents, up from C$1.0200 to the U.S. dollar, or 98.04 U.S. cents, at Friday's close.
The Bank of Canada Business Outlook Survey sparked a rally in the currency and lifted it from its session low as the market took its findings to signal that the central bank would become more hawkish.
In the survey, the Bank of Canada said businesses surveyed in the second quarter were relatively upbeat on their sales outlooks and investment plans compared with the first quarter, even though the economy remained sluggish.
"This was as strong a piece of economic data and as big a surprise as you're ever going to get," said Eric Lascelles, chief economics and rates strategist at TD Securities.
"It's really one of those reports that surprised on several fronts, all in the same direction and all supporting the notion that the Bank of Canada needs to be more hawkish."
The report sent an immediate bid into the Canadian dollar, which shot to C$1.0150 to the U.S. dollar, or 98.52 U.S. cents, moments after it was released. That allowed it to erase losses suffered earlier when a strong U.S. dollar forced the Canadian currency down to C$1.0232 to the U.S. dollar, or 97.73 U.S. cents.
Weakness in the Canadian dollar during the early parts of the session was pegged to weaker commodity prices, which helped send the U.S. dollar higher against a slew of currencies.
But the move in the Canadian dollar was still limited as traders have their sights set on the key report of the week - Canadian jobs data for June - which will be released on Friday.
The June jobs figures, the last data the Bank of Canada will consider ahead of its next scheduled interest rate decision on July 15, are expected to show the economy created 10,000 jobs in June with an unemployment rate of 6.1 percent.
BOND PRICES REBOUND
Canadian bond prices rebounded from an early-session slide as a sharp drop in shares of mortgage company Freddie Mac unsettled investors, while concerns about the upcoming quarterly corporate earning season also played a role.
The slide in Freddie Mac's shares followed projections by Lehman Brothers Inc analysts that it needs to boost capital by $29 billion due to accounting rule changes.
The Toronto Stock Exchange's main index dove nearly 300 points as falling gold and oil prices rattled resource shares, while concerns about corporate earnings chimed in.
"There's a pessimistic tone injected into the market and that's driving the bond market and it's superseded the Business Outlook Survey," Lascelles said.
A report on Monday showed the value of building permits rose 1.1 percent in Canada in May from April, compared with expectations for a 6 percent drop, but it did not have any noticeable impact on bond prices.
A Conference Board of Canada survey showed Canadian consumer confidence slumped to its lowest level in nearly 13 years in June due to the surge in gasoline prices and concern about future economic conditions.
The two-year bond rose 3 Canadian cents to C$101.07 to yield 3.162 percent. The 10-year bond increased 21 Canadian cents to C$102.39 to yield 3.682 percent.
The yield spread between the two-year and 10-year bond was 52.0 basis points, up from 53.1 at the previous close.
The 30-year bond rose 25 Canadian cents to C$116.20 for a yield of 4.044 percent. In the United States, the 30-year Treasury yielded 4.495 percent.
The three-month when-issued T-bill yielded 2.49 percent, unchanged from the previous close. (Editing by Peter Galloway)