Canadian dollar posts biggest loss in 1 month as economy shrinks

By Fergal Smith

TORONTO (Reuters) - The Canadian dollar on Friday weakened by the most in one month against its U.S. counterpart as investors slashed bets on another Bank of Canada interest rate hike after data showed the domestic economy unexpectedly contracting in the second quarter.

The loonie was trading 0.6% lower at 1.3595 to the U.S. dollar, or 73.56 U.S. cents, its biggest decline since Aug. 1. The move nearly wiped out the currency's weekly gain, which was left at 0.1%.

"The Bank of Canada's job is done," said Adam Button, chief currency analyst at ForexLive. "The Canadian dollar is selling off because the debate will quickly shift to when rate cuts are coming. It's not out of the question that we are already in a recession in Canada."

Canadian GDP declined at an annualized rate of 0.2% in the second quarter and growth was most likely flat in July, a signal to the central bank that interest rates are high enough. Analysts had forecast second-quarter growth of 1.2%.

Separate data showed that the contraction in Canada's manufacturing sector gathered pace in August.

Money markets see a 8% chance of a rate hike at the BoC's next policy decision this coming Wednesday, down from 24% before the data. A rate cut is fully priced in by October next year.

Adding to pressure on the loonie, the U.S. dollar erased its earlier losses to strengthen against a basket of major currencies after the U.S. jobs report showed a still strong labor market.

The price of oil, one of Canada's major exports, was a bright spot. It was up 2.2% at $85.44 a barrel. [O/R]

Canadian bond yields were mixed across a steeper curve. The 2-year eased 9.4 basis points to 4.552%, while the 10-year was up nearly half a basis point at 3.569%.

(Reporting by Fergal Smith; Editing by Frances Kerry and Alison Williams)