* C$ falls to C$0.9488 to the U.S. dollar, or $1.0549
* Bond prices rise as odds of fall rate rate hike reduced
* Canada inflation unexpectedly tame in June
By Ka Yan Ng
TORONTO, July 22 (Reuters) - Canada's dollar weakened against the U.S. currency on Friday after a June Canadian inflation reading came in surprisingly tame, prompting lowered odds of interest rate hikes later this year.
Canadian inflation slowed to 3.1 percent in June from an eight-year high of 3.7 percent in May, still a notch above the central bank's 1-3 percent target range. [ID:nN1E76L02X]
Core inflation, which excludes volatile items like gasoline, unexpectedly fell to 1.3 percent in the 12-month period to June from 1.8 percent in May.
"To deliver 1.3 (percent) -- it caught the market looking the other way," said Jack Spitz, managing director of foreign exchange at National Bank Financial.
Both measures of the consumer price index dropped to the lowest year-on-year rate since February and were tamer than forecast by any of the 19 analysts in a Reuters poll. The median forecast was for overall inflation of 3.6 percent and a core rate of 1.9 percent.
The Canadian currency CAD=D4 slipped as low as C$0.9504 to the U.S. dollar, or $1.0522, down from around C$0.9465 to the U.S. dollar, or $1.0565, just prior to the data.
At 8:15 a.m. (1215 GMT), it was at C$0.9488 to the U.S. dollar, or $1.0549, down from Thursday's North American finish of C$0.9454 to the U.S. dollar, or $1.0578.
It had climbed to a 3-1/2 year high in the previous session, spurred by market perceptions of a more hawkish tone in Bank of Canada statements earlier this week as well as optimism that progress was being made by euro zone leaders to keep the sovereign debt crisis contained.
RATE HIKE PRICING LOWERED AGAIN
Canadian government bond prices were mostly higher across the curve, reflecting lowered odds of rate hikes for the rest of the year after the CPI figures suggested interest rates could come at a leisurely pace.
"It buys them a little bit more breathing room," said Mazen Issa, macro strategist at TD Securities.
The two-year bond CA2YT=RR jumped 13 Canadian cents to yield 1.489 percent. Its yield was 1.545 percent just before the data.
The 10-year bond CA10YT=RR gained 31 Canadian cents to yield 2.967 percent.
Overnight index swaps, which trade based on expectations for the central bank's policy rate, showed that traders priced in lower odds of rate hikes in the remaining rate decisions of the year in September, October and December after the data.
A full 25-basis-point rate hike is not priced in until 2012. BOCWATCH
A Reuters poll on Wednesday showed most of Canada's primary dealers expected the Bank of Canada to raise interest rates in September or October. <CA/POLL> [ID:nN1E76J0N0] (Editing by Jeffrey Hodgson)