CANADA FX DEBT-C$ firmer; Bank of Canada less dovish than feared

Wed Sep 7, 2011 10:03am EDT

* C$ at C$0.9889 vs US$ or $1.0112

* Bank of Canada dovish, but not as much as expected

* Bonds prices fall across curve; mostly underperform U.S.

By Andrea Hopkins

TORONTO, Sept 7 (Reuters) - The Canadian dollar strengthened on Wednesday after the Bank of Canada warned of a worsening global economic picture but was not as dovish about interest rates as traders had expected.

In a policy shift, Canada's central bank said there was less need to raise interest rates because of slowing global economic momentum, but policymakers also said Canadian growth would resume in the second half of the year, with very stimulative credit conditions a factor. [ID:nN1E786055]

The bank held its key interest rate steady at 1 percent, as expected.

Analysts said that while the bank noted there is less need to withdraw policy stimulus -- less need to raise rates -- than seen in July, it also did not hint at any need for a rate cut.

"This might not have been quite as dovish overall, as some may have been expecting, given the fact that the market was actually priced for rate cuts at some point in the months ahead," said Doug Porter, deputy chief economist at BMO Capital Markets.

The Canadian dollar initially weakened in a knee-jerk reaction to the central bank statement, but quickly recovered strength as traders mulled the hawkish elements of the statement.

"It still has these lingering elements of the hawkish. Most, including ourselves, were looking for more of an overt move to neutrality that would have in a sense sidelined any talk of the need to withdraw monetary stimulus," said Stewart Hall, currency strategist for RBC Capital Markets.

Higher interest rates tend to strengthen currencies by attracting international capital flows, and vice versa.

At 9:34 a.m. (1334 GMT), the Canadian currency CAD=D4 stood at C$0.9889 versus the U.S. dollar, or $1.0112, up from Tuesday's North American session close at C$0.9898 to the U.S. dollar, or $1.0103. It had touched a session low of C$0.9912 to the U.S. dollar, or $1.0089, immediately after the rate announcement.

The Canadian dollar is also expected to take direction from global factors on Wednesday as the central bank statement is digested.

World stocks rose from a two-week low and the euro rallied across the board after Germany's top court rejected lawsuits aimed at blocking Berlin's participation in bailout packages for Greece and other euro zone countries. [MKTS/GLOB]

Higher energy prices, boosted by expectations of lower U.S. crude stocks, also underpinned commodity-linked currencies such as Canada's, as did better-than-expected Australian growth numbers overnight. [O/R] [ID:nL3E7K70A2]

A Reuters survey of 43 forecasters had unanimously predicted the Bank of Canada would keep its overnight target rate at 1 percent. [CA/POLL]

Canadian bond prices retreated across the yield curve.

The two-year bond CA2YT=RR, which is especially sensitive to Bank of Canada interest rate moves, was off 9.5 Canadian cents to yield 0.907 percent. It yielded 0.88 percent before the rate news.

The 10-year bond CA10YT=RR slipped 22 Canadian cents to yield 2.265 percent, up from 2.248 percent before the announcement. (Editing by Jeffrey Hodgson)

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