Canadian dollar dips on rate hike talk, bonds flat

TORONTO - The Canadian dollar dropped versus the U.S. dollar on Friday, dragged down by uncertainty surrounding the Bank of Canada's interest rate outlook and a generally stronger greenback.

Domestic bond prices were flat with a bias to the upside. But with no Canadian data due for release traders could look south of the border to U.S. Treasuries for direction.

At 8:50 a.m. (1250 GMT) the currency was at C$1.1240 to the U.S. dollar, or 88.96 U.S. cents, down from C$1.1189 to the U.S. dollar, or 89.37 U.S. cents, at Thursday's close.

Comments from Bank of Canada Governor David Dodge earlier this week rattled the Canadian dollar as his suggestions that an eighth-straight rate hike is not a sure thing spoiled the excitement surrounding a string of robust economic reports.

"It seems to be that since Mr. Dodge has spoken it's taken the shine off the currency and the market seems to have very quickly forgotten about all the fabulous bits of data we saw earlier in the week and last week," said Steve Butler, director of foreign exchange at Scotia Capital.

"The market's just basically been focusing on the U.S. dollar strength and we've seen it really just take front and center stage for the moment in the currency world."

Much of the driving force behind the U.S. dollar's strength has come from speculation that the U.S. Federal Reserve might increase interest rates by half a percentage point next week despite forecasts for a quarter point hike to 5.25 percent.

The Canada-U.S. interest rate gap favors the greenback, with the fed funds rate at 5 percent compared with the Bank of Canada's 4.25 percent overnight rate.

The shift in sentiment on Canadian interest rates has come suddenly, as signs of strength in jobs growth, retail spending and inflation wiped out memories of the Bank of Canada's recent suggestions that it was likely finished raising rates.

But Dodge said month-to-month indicators can be volatile, and noted the bank makes its rate decisions with an eye to conditions 12 to 24 months down the road.

"Obviously the market is banking on the Fed going next week and then with the Bank of Canada shortly thereafter we'll have to see exactly if they follow suit, and then what's going to happen going forward and how far exactly the Fed is going to go," said Butler.

The U.S. Federal Reserve decides on interest rates on Thursday, while the Bank of Canada is holding its next policy meeting on July 11.