Canadian dollar gains despite oil drop as Fed's Yellen talks caution

TORONTO (Reuters) - The Canadian dollar strengthened to a near one-week high against its U.S. counterpart on Tuesday after Federal Reserve Chair Janet Yellen said the U.S. central bank should proceed “cautiously” with rate hikes.

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

The comments offset factors that would have otherwise weighed on the Canadian currency, including a drop in oil prices and soft domestic data, and also repudiated more hawkish statements from other Fed officials in recent days.

“It’s really now or never for them to raise one more time or maybe two more times, and I just don’t think that’s going to happen,” said Blake Jespersen, managing director of foreign exchange sales at BMO Capital Markets.

The Fed raised rates in December for the first time in nearly a decade but has since paused its tightening, downgraded its economic expectations and cut its prediction to two hikes this year from four eyed in December.

The Canadian dollar CAD=D4 settled at C$1.3065 to the greenback, or 76.54 U.S. cents, much stronger than Monday's close of C$1.3181, or 75.87 U.S. cents, touching its strongest level since March 23.

The currency rose despite a drop in oil prices of some 3 percent, reflecting growing concern a two-month rally was fading as demand fails to keep up with swelling global supply.

The currency also brushed off the largest drop in Canadian producer prices in more than a year in February.

A more cautious Fed and oil holding on to recent gains could help the Canadian currency make further gains.

“If the Fed stance remains as is and oil continues to push above $40 then you’re going to see the Canadian dollar probably at C$1.25,” BMO’s Jespersen said, adding C$1.38 would likely prove stiff resistance for any renewed Canadian dollar weakness.

January gross domestic product data is due on Thursday, with analysts expecting 0.3 percent growth for the month, which would reinforce expectations that first-quarter growth will exceed the Bank of Canada's forecast of 1 percent. ECONCA

U.S. jobs data on Friday will also be closely watched for its implications for the Fed.

Canadian government bond prices were higher across the maturity curve, with the two-year CA2YT=RR price up 10.5 Canadian cents to yield 0.513 percent. The benchmark 10-year CA10YT=RR rose 69 Canadian cents to yield 1.179 percent, its lowest level in three weeks.

Additional reporting by Fergal Smith; Editing by Lisa Von Ahn and Diane Craft