CANADA FX DEBT-C$ hits 2-week high on inflation, commodity surge

* C$ rises to C$0.9706 to US$, or $1.0303

* Touches strongest level since June 15

* Unexpectedly high Canadian inflation data drives gains

* Higher oil, commodity prices support

* Bonds lower, Canada underperforms Treasuries

By Trish Nixon

TORONTO, June 29 (Reuters) - Canada’s dollar jumped more than a penny to its strongest in two weeks on Wednesday, boosted by domestic inflation data and Greece’s approval of an austerity plan, which fueled buying of commodity-linked currencies.

Data showed inflation in Canada rose to its highest level since 2003 in May, raising the prospect the central bank will lift interest rates sooner than previously expected. [ID:nN1E75S02V]

“The CPI (consumer price index) data came out much stronger than anticipated and really that set the tone for the day in Canada,” said Steve Butler, director of foreign exchange trading at Scotia Capital.

Canadian inflation shot up to 3.7 percent in May, well above expectations and the Bank of Canada’s 2 percent target.

Overnight index swaps, which trade based on expectations for the key central bank rate, showed that traders priced in an increased probability of rate hikes later this year following the data, though a full 25-basis-point rate hike was not priced in until 2012. BOCWATCH

Higher interest rates tend to help a country’s currency appreciate because they often attract international capital flows.

“It’s a wait-and-see scenario, but certainly the expectations have jumped, and the possibility that we will see another (interest rate) move at some point this year is more real than it was at 6:59 this morning,” said Butler

Canada’s currency also benefited from improved global market sentiment, as commodities, global stocks and the euro all rose after Greece’s parliament approved a five-year austerity plan designed to prevent the country from going bankrupt. [MKTS/GLOB]

“Commodity prices are up. The U.S. dollar is a little bit weaker which isn’t hurting in that regard. As a result we are getting some expression of interest to buy commodity currencies back,” said David Watt, senior currency strategist at RBC Capital Markets.

Oil jumped 3 percent, and copper hit its highest in nearly two months months as risk appetite improved following the vote in Greece. [O/R] [MET/L]

Canada's currency CAD=D3 ended at C$0.9706 to the U.S. dollar, or $1.0303, up from Tuesday's finish at C$0.9827 to the U.S. dollar, or $1.0176.

Earlier in the session it climbed as high as C$0.9689 to the U.S. dollar, it’s strongest level since June 15.

Butler warned the strength of Canada’s currency could wane in the near-term as external events unfold. He cited the contagion effects out of Greece and the U.S. debt situation as causes for concern.

“I think there’s going to be a lot more turmoil and I wouldn’t be surprised still to see the market unsettled. With that we might see the Canadian dollar bounce back toward parity at some point.”

Canadian bond prices were lower as investors moved away from the relative safety of government debt to dip back into riskier assets.

The two-year bond CA2YT=RR slipped 23 Canadian cents to yield 1.56 percent, while the 10-year bond CA10YT=RR gave back 87 Canadian cents to yield 3.09 percent.

Canadian bonds underperformed U.S. Treasuries. Canada’s benchmark 10-year yield was 3.4 basis points below its U.S. counterpart, compared with 4.5 basis points on Tuesday. (Editing by Jeffrey Hodgson)