December 9, 2008 / 10:10 PM / in 9 years

CANADA FX DEBT-C$ falls, bonds rise as more rate cuts seen

* Bank of Canada cuts key rate to 50-yr low of 1.5 pct

* Canadian dollar finishes volatile session lower

* Bonds rise, short end gains as BoC declares recession

By Ka Yan Ng

TORONTO, Dec 9 (Reuters) - The Canadian dollar fell more than half a U.S. cent on Tuesday after the Bank of Canada cut its key interest rate by a bigger than expected 75 basis points and declared for the first time that the Canadian economy is entering a recession.

Bond prices rose sharply, reflecting expectations of further rate cuts as the economy weakens.

The currency finished at C$1.2646 to the U.S. dollar, or 79.08 U.S. cents, down from C$1.2540 to the U.S. dollar, or 79.74 U.S. cents, at Monday’s close.

The Canadian dollar fell as low as C$1.2743, or 78.47 U.S. cents, after the rate decision, from C$1.2640, just before the Bank of Canada cut its overnight rate to a 50-year low of 1.5 percent. [ID:nN092350]

Most analysts had expected a cut of at least a 50 basis points but talk had been growing that there would be more aggressive action.

The Canadian dollar was able to claw back some of the losses by midday as the U.S. dollar was unable to hold on to its early gains against other major currencies, particularly the euro. Then it promptly turned around again as the focus returned to the outlook for the global economy.

“We did see a little bit of a knee-jerk reaction to push dollar/Canada higher after the announcement itself, but we quickly ran out of steam up ahead of the C$1.2750 level,” said George Davis, chief technical analyst at RBC Capital Markets.

“Normally, the things that would have allowed the Canadian dollar to weaken further, those variables were ignored to a certain extent.”

Usual factors that influence the Canadian dollar, such as the price of crude, were set aside temporarily in favor of concentrating on the economic outlook from the Bank of Canada.

While it was the first clear admission by the central bank that Canada is joining most major economies in sliding into recession, the Bank of Canada also said it sees a “broader and deeper” global downturn than previously anticipated.

“Virtually all market watchers are expecting central banks to cut interest rates,” said Jack Spitz, managing director of foreign exchange at National Bank Financial.

“At issue now is the forward-looking guidance. (Bank of Canada Governor Mark) Carney’s guidance, as expressed in the communique, was extremely bearish.”

SHORT-END RISES

Unlike previous statements, the bank did not explicitly signal further cuts were necessary but it appeared to leave the door open to additional easing in 2009. That triggered a push lower in Canadian bond yields, particularly in the interest-rate sensitive short end of the curve.

Some forecasters estimate the overnight rate will fall another 50 basis points to hit a floor of 1 percent, with risk for further easing below that level if the economy suffers a protracted downturn.

The two-year bond rose 6 Canadian cents to C$102.31 to yield 1.556 percent. The 10-year bond rose 3 Canadian cents to C$109.53 to yield 3.082 percent.

The yield spread between the two- and 10-year bond was at 155 basis points, up from 151 basis points at the previous close.

The 30-year bond climbed 40 Canadian cents to C$121.80 to yield 3.748 percent. In the United States, the 30-year treasury yielded 3.0358 percent. (Reporting by Ka Yan Ng; editing by Rob Wilson)

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