* C$ at C$0.9488 to the U.S. dollar, or $1.0549
* C$ had reached strongest since Nov. 2007 on Thursday
* Tame Canada June inflation cools rate hike expectations
* Bond prices boosted by inflation data
* C$ catches brief respite from strong May retail sales (Updates with details)
By Ka Yan Ng
TORONTO, July 22 (Reuters) - Canada's dollar was lower against the U.S. currency on Friday after a June Canadian inflation reading came in surprisingly tame, reducing expectations that interest rates will rise 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, after the inflation data.
It briefly pared losses to trade at C$0.9467 to the U.S. dollar, or $1.0563, immediately following data showing retail sales grew by a stronger-than-expected 0.1 percent in May from April. [ID:nN1E76L00W]
But it quickly returned to lower levels as the CPI figures were the more dominant piece of economic data on Friday.
"The retail sales number was a good number but it's not going to drive the Bank of Canada to raise rates in and of itself," said Shane Enright, executive director, foreign exchange sales at CIBC World Markets.
"But there certainly is a possibility that the Canadian inflation number will deter them from raising rates. So on that front, it's a much more significant number."
He said the Canadian dollar had likely touched its weakest level for the session, although there was "some scope" for it to soften a bit more if global macro sentiment deteriorated.
"The market for now is a little bit more predisposed to buy dollar/Canada on dips," said Enright.
At 9:11 a.m. (1311 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, reflecting lowered odds of rate hikes for the rest of the year after the inflation figures suggested interest rates could come at a more 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, particularly sensitive to short-term interest rates expectations, gained 14 Canadian cents to yield 1.487 percent, compared with a yield of 1.545 percent ahead of the CPI data.
The 10-year bond CA10YT=RR advanced 41 Canadian cents to yield 2.955 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)