CANADA FX DEBT-C$ rallies on risk recovery, inflation surprise

* C$ hits session high of C$1.0139 vs US$, or 98.63 U.S.
    * 2-yr bond yield climbs after stronger-than-expected
    * Total inflation 2.0 pct annually

    By Claire Sibonney	
    TORONTO, May 18 (Reuters) - The Canadian dollar bounced up
from more than a four-month low against the U.S. currency on
Friday as riskier assets recovered from a violent, Europe-led
sell-off this week and data showed Canada's inflation rate rose
more than expected in April.	
    The country's inflation edged up to 2.0 percent, versus
expectations for a 1.9 percent increase, matching the Bank of
Canada's target as gasoline prices rose.  	
    Following the release, the currency firmed to
C$1.0139 against the greenback, or 98.63 U.S. cents, from around
C$1.0164, or 98.39 U.S. cents immediately before the data.	
    "The number was relatively firm, if you look at where it
came from it was in some of the more volatile categories ...
this suggests the Bank of Canada will probably sort of look
through the number," said Mark Chandler, head of fixed income
and currency strategy at RBC Capital Markets.	
    "I don't think the market impact will be that great either,
obviously because of the environment that we are in."	
    The currency was already on stronger footing heading into
the report. It recovered from a more than 3 percent drop this
week to back below 98 U.S. cents on Friday, a day after Moody's
cut its rating on Spanish banks en masse, heightening fears of
contagion from the Greek political crisis. 	
    Following the data, traders slightly raised bets of an
interest rate increase by the Bank of Canada later this year,
but that probability has come down over the course of the week.
    "From a strictly domestic standpoint, I think it does
advance the case for the bank raising rates. Having said that,
the bank also has to, of course, deal with the reality of a
further flare up in the European situation, and I think that's
going to overwhelm domestic considerations," said Doug Porter,
deputy chief economist at BMO Capital Markets.	
    At 9:10 a.m. (1310 GMT), the Canadian dollar stood at
C$1.0166 versus the U.S. dollar, or 98.37 U.S. cents, up from
Thursday's North American session close at C$1.0191 versus the
U.S. dollar, or 98.13 U.S. cents. Earlier, the currency dropped
as low as C$1.0227, or 97.78 U.S. cents, its weakest since Jan.
    The currency was largely following the direction of rising
U.S. stock index futures after a rough week on the back of
Europe's escalating debt crisis.	
    U.S. futures edged up, but major global indexes were set up
to close their worst week of the year. Facebook Inc's 
long-expected debut could help lift otherwise battered investor
    "It felt like people were bracing themselves for financial
market Armageddon," said Jeremy Stretch, head of currency
strategy at CIBC in London.	
    "There might be a little of consolidation today, but it's
more of a case of looking to lock in a little bit of profit
after a pretty violent week, and I think people will come back
and reassess at the beginning of next week."	
    Stretch said that the Canadian dollar must close
substantially firmer than C$1.0140 versus the U.S. dollar, or
98.62 U.S. cents, in order to see a potential turn in sentiment
for the domestic currency.	
    "I don't foresee that happening even though risk is looking
a little better bid at this point in the day. It's going to be
tough, and I probably still prefer to be long dollar/CAD into
the start of next week overall."	
    Canadian government bonds lagged U.S. Treasuries prices at
the short end of the curve and outperformed at the long end.
    The yield on the two-year Canadian government bond
, which is especially sensitive to Bank of Canada
interest rate moves, rose to 1.25 percent from 1.228 percent
just before the release. 	
    Canada's 10-year yield dropped to 1.883, from
around 1.891 percent.