By Cameron French
TORONTO (Reuters) - The Canadian dollar charged to a new 29-1/2 year high on Tuesday, while bonds sank, as the Bank of Canada left interest rates unchanged but signaled it could raise rates in the near future.
The currency finished at C$1.0735 to the U.S. dollar, or 93.15 U.S. cents, up from C$1.0803, or 92.57 U.S. cents, at Monday's close.
The central bank said in a statement that persistent inflationary pressures meant it may need to tighten policy in the "near future," prompting forecasters to bring forward their rate hike timetables, while currency traders anticipated a higher yield on Canadian investments.
"It was a real jaw-dropper of a day. I think the market was expecting hawkish report from the Bank of Canada, but they really let it out," said Steven Butler, director of foreign exchange at Scotia Capital.
The Canadian dollar pushed as high as C$1.0711, or 93.36 U.S. cents, its highest level since September 1977.
The currency has now risen about 10 percent since mid-March amid rising inflation, strong commodity prices, and several announced takeovers of Canadian companies.
In its statement, the bank linked the recent rise of the Canadian dollar to strong commodity prices, language that suggested it does not expect the higher currency to do the job of rate hikes and cool the economy.
Such language makes the market more comfortable with a higher currency, Butler said.
"I thought they'd either avoid the currency or try to talk their way around it. But they basically said the move's been orderly, the move's been based on fundamentals," he said.
He said he expected the currency to continued to appreciate toward the C$1.05 level, but noted any hiccup in the recent strong economic signals could prompt a quick pullback.
Speaking in Ottawa, Finance Minister Jim Flaherty told reporters that he was concerned about the effect the strong Canadian dollar was having on manufacturers, but said he supported the Bank of Canada's statement.
BONDS DROP
Canadian bond prices fell hard on the Bank of Canada's statement, as the market began pricing in a summer rate hike.
Bond prices usually fall when rates are set to rise because the expectation of higher debt yields make previously-issued bonds less appealing.
A Reuters poll taken on Tuesday showed a majority of Canadian dealers now expect rate hikes in July and August, while a poll taken last week showed most expected no rate moves until late in the year.
The period of steady rates thus far, dating back to May 2006, is the Bank of Canada's longest since a 17-month stretch in the early '70s.
The two-year bond dropped 26 Canadian cents to C$98.42 to yield 4.586 percent, while the 10-year bond fell 56 Canadian cents to C$96.34 to yield 4.499 percent.
The yield spread between the two-year and 10-year bond was -8.7 basis points, compared with -2.1 basis points at the previous close.
The 30-year bond fell 50 Canadian cents to C$120.40 to yield 4.422 percent. In the United States, the 30-year treasury yielded 5.019 percent.
The three-month when-issued T-bill yielded 4.32 percent, up from 4.20 percent at the previous close.
© Reuters Limited. All Rights Reserved.
Reproduction or redistribution of Reuters content, including framing or similar means, is expressly prohibited without the prior written consent of Reuters. Reuters shall not be liable for any errors or delays in the content, or for any actions taken in reliance thereon.
