C$ gains as Bank of Canada expresses optimism

TORONTO (Reuters) - The Canadian dollar hit its strongest level since July 7 against its U.S. counterpart on Wednesday after the Bank of Canada held rates steady and trimmed its economic forecasts, as traders unwound bets that the central bank could cut rates this year.

A Canadian dollar coin, commonly known as the "Loonie", is pictured in this illustration picture taken in Toronto January 23, 2015. REUTERS/Mark Blinch

Still, analysts said the currency faces an uphill battle to strengthen further despite the central bank’s optimism that exports and business investment would pick up, as economic data in coming months will likely remain less than robust.

“You still have a lot of weak data to wade through and the bar has been set relatively high for growth,” said Mark Chandler, head of Canadian fixed income and currency strategy at Royal Bank of Canada. “There’s room for disappointment in the near term.”

The Canadian dollar settled at C$1.2986 to the greenback, or 77.01 U.S. cents, stronger than the Bank of Canada’s official Tuesday close of C$1.3030, or 76.75 U.S. cents.

It touched C$1.2936 soon after the central bank’s updated outlook was published, versus C$1.3069 just before.

Economists said the bank’s comments did not do enough to bolster a minority view that rates would need to be trimmed this year.

“While we can’t rule it out, I’d say there really isn’t much sense here that the Bank’s leaning in that direction, so the initial reaction has been a stronger Canadian dollar and I think that’s appropriate,” said Doug Porter, chief economist at BMO Capital Markets.

Overnight index swaps, which track expectations for the central bank’s main policy rate, showed traders reduced bets on a rate cut following the news.

The Canadian currency rose despite a sharp drop in oil prices after the International Energy Agency warned that a global supply glut threatened a price recovery and data showed an unexpected weekly gain in U.S. crude stocks. [O/R]

Canada is a major exporter of oil.

Canadian government bond prices were higher across the maturity curve, with the two-year price up 2 Canadian cents to yield 0.495 percent and the benchmark 10-year rising 52 Canadian cents to yield 1.004 percent.

“What the market is telling us is that they don’t believe that the Bank of Canada is going to be normalizing rates any time soon,” said Royce Mendes, a senior economist at CIBC Capital Markets, referring to an interest rate hike.

The Canada-U.S. two-year bond spread narrowed to -17.4 basis points, while the 10-year spread was at -47.1 basis points.

Additional reporting by Susan Taylor and Matt Scuffham; Editing by Jeffrey Hodgson and Richard Chang