* C$ weakens to $1.0384
* Bond prices rise firmly across curve
* Bank of Canada hold rates at 1 percent
* BoC expects inflation to hit target sooner than thought
* BoC cites persistent C$ strength as potential headwind (Adds details)
By Solarina Ho
TORONTO, April 12 (Reuters) - The Canadian dollar softened on Tuesday morning after the Bank of Canada held interest rates at 1 percent, as expected, and again cited the "persistent strength" of the Canadian dollar.
The central bank warned that the high-flying Canadian dollar was putting downward pressure on inflation, saying this could create "even greater headwinds for the Canadian economy."
"In two separate instances, they point to the challenges that were imposed upon the economy by the strong Canadian dollar. It's a theme they want to get across," said Doug Porter, deputy chief economist at BMO Capital Markets.
The central bank reiterated comments made in its March 1 policy announcement, hinting that a May 31 interest rate hike was unlikely. But it set the stage for rate increases later this year by predicting inflation would hit the bank's target six months earlier than previously thought. [ID:nN12159489]
The Bank of Canada also raised its economic growth forecast for 2011 to 2.9 percent from 2.4 percent, but it trimmed its estimates for 2012. Overall growth expectations were mostly unchanged from its January forecasts.
"All in all the statement was pretty much what most of us expected: a slight warning for the strength of the Canadian dollar and how that impacts the economy," said Camilla Sutton, chief currency strategist, Scotia Capital.
At 10:20 a.m. (1420 GMT), the currency CAD=D4 was at C$0.9630 to the U.S. dollar, or $1.0384, down from Monday's North American finish of C$0.9565 to the U.S. dollar, or $1.0455, which was close to a 3-1/2 year high.
Market focus now is on the bank's monetary policy report and news conference on Wednesday morning, with traders set to parse any further comments on the strength of the Canadian dollar.
BOND PRICES FIRM
Money market rates and bond yields fell slightly after the rate announcement as investors reduced slightly the likelihood of rate hikes at the Bank of Canada's next policy announcement date in May.
Overnight index swaps, which trade based on expectations for the key central bank rate, now show just a 7.72 percent chance of a rate hike on May 31, compared with 26.61 percent before the statement. A September rate hike remains the first fully priced in by the market with a 25 basis point rise seen. BOCWATCH
In a Reuters poll of economists and strategists released last week, however, the median forecast was for the bank to make the first interest rate hike of the year on July 19. [CA/POLL]
The two-year bond CA2YT=RR, which is especially sensitive to Bank of Canada policy moves, was up 14 Canadian cents to yield 1.868 percent, while the 10-year bond CA10YT=RR added 48 Canadian cents to yield 3.426 percent. (Additional reporting by Claire Sibonney and Ka Yan Ng; editing by Peter Galloway)