* C$ rises to 97.21 U.S. cents
* BHP bid for Potash turns hostile
* Government bond prices rise across much of curve
* Five-year note auction sees solid demand (Updates to close, adds quotes)
By Claire Sibonney
TORONTO, Aug 18 (Reuters) - The Canadian dollar rallied against its U.S. counterpart for a second day on Wednesday, supported by BHP Billiton's BHP.AXBLT.L takeover bid for Canada's Potash Corp POT.TOPOT.N.
BHP took the $39 billion takeover offer -- the largest so far this year -- directly to shareholders on Wednesday, a day after Potash's POT.TO board rejected it as "grossly inadequate". [ID:nSGE67H031]
The bid by Anglo-Australian BHP, the world's biggest miner, has boosted the currency because a successful offer from any international player would result in the purchase of Canadian dollars.
The suitor could either buy Canadian dollars to pay for the tens of millions of Potash shares held by Canadian investors, or pay in U.S. dollars and leave the conversion up to shareholders.
BHP's $130 a share offer has sent Potash stock soaring as investors anticipate it may become richer.
"One thing that is clear, it seems like the spot market likes to react first and ask questions later so we've definitely seen Canada doing better and Aussie underperform on the back of the news yesterday," said Steve Butler, director of foreign exchange trading at Scotia Capital.
"It does make a certain amount of sense but I think adding on a fresh position on the back of this may be a bit premature because again a lot can happen between now and then if the deal does close in a couple months."
Analysts said Canada's currency could rise to equal value with the U.S. dollar for the first time since April if the deal goes through, though they warned that strength could prove fleeting given global economic weakness. [ID:nN17146793]
The Canadian dollar CAD=D4 closed the North American session at C$1.0287 to the U.S. dollar, or 97.21 U.S. cents, up from Tuesday's finish of C$1.0329 to the U.S. dollar, or 96.81 U.S. cents.
Butler said intraday moves through the 200-day moving average at C$1.0320 on Tuesday and Wednesday were a bullish sign for the Canadian currency and market watchers are now eyeing C$1.0150.
"After a really tough week last week if stocks continue to press higher that bodes well for Canada short term," he added. Butler cautioned, however, that until a Potash deal is consummated, the market will remain skittish.
Analysts warn the economic backdrop for the Canadian dollar is shaky, particularly if the U.S. economic recovery remains tepid. CIBC World Markets on Wednesday said it had trimmed its forecast for rate hikes and currency strength in Canada as the economic growth outlook dampens abroad.
Markets are pricing in roughly a 53 percent chance of a 0.25 percent rate hike on Sept. 8. Most of Canada's primary dealers have forecast a pause in rate hikes in October. BOCWATCH[CA/POLL]
HEALTHY APPETITE FOR BONDS
As evidence of slower growth in both Canada and the United States has emerged in recent weeks, government bond prices have rallied as investors seek the relative safety of these assets.
Canada's two-year bond CA2YT=RR was up half a Canadian cent to yield 1.391 percent, while the 10-year bond CA10YT=RR added 20 Canadian cents to yield 2.934 percent.
Canada's auction of five-year bonds attracted solid demand on Wednesday despite competition from Canada Housing Trust's sale of C$3.55 billion of bonds. [ID:nN18193944]
"You've seen the slower global growth outlook and the market has helped drive yields lower and the market has gotten comfortable that the Bank of Canada is going to proceed very cautiously on its path for its policy normalization," said said Fergal Smith, managing market strategist at Action Economics.
"That's been very helpful for the front of the curve and the belly of the curve in Canada," he added, also noting data on Tuesday that showed robust foreign interest in Canadian bonds in June. [ID:nN17122886] (Reporting by Claire Sibonney; editing by Peter Galloway)