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News from Reuters

Friday, March 26, 2004

By Ka Yan Ng

TORONTO (Reuters) - The Canadian dollar shifted into high gear on Friday, reaching a three-week high, as a stronger than expected domestic retail sales suggested the Bank of Canada could hold off cutting interest rates.

Domestic bond prices slumped as investors tweaked their positions on interest rates.

The Canadian currency rose for a second consecutive session, finishing at C$1.3184 to the U.S. dollar, or 75.85 U.S. cents, up from C$1.3292, or 75.23 U.S. cents, at Thursday's close.

It shot as high as C$1.3161, according to Reuters data, in the aftermath of the unexpectedly robust retail sales data, before slouching.

"This is basically an adjustment in expectations. Today at 8:29 a.m., the market expected about 100 percent probability (of a rate cut)," said Benjamin Tal, senior economist at CIBC World Markets.

"At 8:31, the probability dropped somewhat. The market is still counting on it, but less than before."

Canadian retail sales, data which was released at 8:30 a.m. on Friday, rose 1.6 percent in January from December, well above market estimates of a 0.4 percent gain. Statscan revised December's sales to a 1.3 percent fall from a preliminary drop of 1.2 percent.

With very little domestic economic news to contribute to interest rate expectations during the week, investors were eager for the retail sales number, despite its relatively stale read for January.

The market is geared for the Bank of Canada to cut its key overnight interest rate for a third time this year, though the retail sales figure may have tempered some forecasts as bonds dropped sharply and the Canadian dollar rallied.

The central bank next sets its policy on April 13.

The benchmark rate now sits at 2.25 percent, compared with 1 percent in the U.S., and this gap has helped attract investors looking for higher-yielding currencies.

Meanwhile, analysts were dismayed that Canadian wholesale trade data was swept aside by the focus on retail sales. Wholesale trade fell 3.2 percent in January from December.

Excluding motor vehicles, wholesale trade in January fell 0.4 percent. Analysts had expected, on average, that overall wholesale trade would dip 0.1 percent from December. December's data was revised to show a 1.2 percent gain from a preliminary 0.8 percent rise.

"Wholesale trade is a bigger sector than retail in Canada, about C$10 billion more. That sector fell 3.2 percent. If you put the two together, you end up with about a 1.2 percent decline for the month," said Andrew Pyle, senior financial markets economist at Scotia Capital.

"That means next week's GDP report is going to be pretty flimsy."

The gross domestic product report for January is due Wednesday.

BONDS FALL SHARPLY

Domestic bond prices fell steeply, particularly in longer-dated issues, after the retail sales data.

"The markets shouldn't have done what they did today," said Pyle. "In terms of the outlook for interest rates for the Bank of Canada, it would be erroneous to look at that retail sales report as pushing the bank away from a significant move in rates, if that's what the bank wanted to do."

Losses mounted as the University of Michigan consumer sentiment index also proved upbeat.

The index's final reading of consumer confidence inched ahead to 95.8 in March from 94.4 in February. The preliminary reading put the index at 94.1, while economists had been looking for the final measure to ease to 93.7.

The two-year bond fell 4 Canadian cents to C$101.18 to yield 2.274 percent, while the 10-year bond lost 80 Canadian cents to C$107.20 to yield 4.291 percent.

The yield spread between the two-year and 10-year bond moved to 201.7 basis points from 200.0 at the previous close.

The 30-year bond, due 2029, dropped C$1.28 to C$110.94 to yield 4.982 percent. In the United States, the 30-year treasury yielded 4.765 percent.

The three-month when-issued T-bill yielded 1.98 percent, up from 1.96 percent from the previous close.

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