June 21, 2010 / 8:53 PM / 7 years ago

CANADA FX DEBT-C$ gives way to fiscal concerns, China move fades

* C$ slips to 97.62 U.S. cents

* China move to allow yuan flexibility boosts markets

* Canadian officials encouraged by yuan move but wary

* BoC says risks in Canada’s financial system higher

* Canadian bond prices fall as equities rise (Updates to close)

By Ka Yan Ng

TORONTO, June 21 (Reuters) - The Canadian dollar tumbled from a five-week high against the U.S. currency to end lower on Monday as market enthusiasm for China’s plans to allow its currency more flexibility gave way to concerns about fiscal discipline.

China’s weekend announcement that it will let the yuan rise was seen as a signal of confidence in its economy, boosting equity markets worldwide, as well as commodity prices.

The rise in risk sentiment helped the Canadian dollar climb to C$1.0138 to the U.S. dollar, or 98.64 U.S. cents, its highest level since May 13.

But it lost about a penny from its intraday high to end the session at C$1.0244 to the U.S. dollar, or 97.62 U.S. cents, down from Friday’s close at C$1.0212 to the U.S. dollar, or 97.92 U.S. cents.

“Ultimately, the optimism was short-lived and throughout the North American trading session it quickly faded ... turning into mild risk aversion,” said Matthew Strauss, senior currency strategist at RBC Capital Markets.

“The market focus is quickly returning to the broader issues of fiscal discipline,” he said, adding that markets will be monitoring Britain’s emergency budget, due Tuesday.

Britain is expected to announce the tightest budget in at least 30 years to cut a record deficit of around 11 percent of GDP, the latest country that will have to present austere measures to deal with its debt. [ID:nLDE65G22W]

The focus on fiscal consolidation was underscored by the Bank of Canada, which said in its twice-yearly Financial System Review that overall risk to the stability of Canada’s financial system has increased over the past six months. The central bank warned that the financial system will be vulnerable unless rising government debt levels are dealt with. [ID:nN21243332]

The Canadian currency also lost some steam after Finance Minister Jim Flaherty said the Group of 20 nations will want more details on the yuan plan. In addition, Prime Minister Stephen Harper said he was encouraged by China’s decision but wanted to see the results. [ID:nN21249551] [ID:nNYC003401]

China’s central bank has maintained the yuan’s peg to the U.S. dollar since the middle of 2008, a controversial policy aimed at steadying the world’s fastest growing major economy during the global economic downturn. [ID:nN20208975] [ID:nN21251910]

“It’s backed off of its highs because of comments that were attributed to the finance minister and the prime minister, as well as the Bank of Canada’s financial review,” said Jack Spitz, managing director of foreign exchange at National Bank Financial.

BONDS SLIP AS STOCKS HOLD GAINS

Canadian government bond prices were flat to lower across the curve, as China’s yuan move spurred thin gains in equity markets.

Markets could be in for a volatile period as the G20 summit arrives in Toronto at the end of the week, and ahead of other key economic data on Tuesday.

Canadian data on tap includes inflation figures for May, as well as retail sales for April.

As well, the U.S. Federal Reserve is expected to reiterate its commitment to keeping interest rates “exceptionally low” for an “extended period” when it sets interest rates on Tuesday. [ID:nN18127782] [ID:nN17269337]

The two-year government bond CA2YT=RR was unchanged to yield 1.739 percent, while the 10-year bond CA10YT=RR was off 4 Canadian cents to yield 3.327 percent.

Canadian bonds outperformed U.S. Treasury issues across the curve. The Canadian 10-year bond yield was 7.9 basis points above its U.S. counterpart, compared with 9.7 basis points on Friday. (Reporting by Ka Yan Ng; editing by Rob Wilson)

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