CANADA FX DEBT-C$ notches a 2-week high as inflation picks up

* Canadian dollar at C$1.2586, or 79.45 U.S. cents

* Loonie at session high touches its strongest since

* Bond prices mixed across the yield curve

* 10-year spread vs U.S. Treasuries narrows by 1.2 basis points

TORONTO, Aug 18 (Reuters) - The Canadian dollar rose to a two-week high against its U.S. counterpart on Friday, as data showing an uptick in the Bank of Canada's core measures of inflation supported the view that the central bank will raise interest rates in the fall. Canada's overall annual inflation rate rose to 1.2 percent from June's 20-month low of 1.0 percent, matching analysts' expectations. Two of the three measures of core inflation that the Bank of Canada introduced last year saw gains, Statistics Canada said. "They (the core measures) are trending higher, and this is consistent with the output gap being almost closed," said Jimmy Jean, senior economist at Desjardins Capital Markets. The output gap is the difference between what an economy produces and its potential production, without overheating. Desjardins sees the Canadian central bank on track to hike rates again in the fall. Strengthening in the domestic economy prompted the central bank to raise interest rates in July for the first time in nearly seven years. The market sees a two-in-three chance of another hike in October, overnight index swaps figures show, little changed from before the inflation data. The bank's benchmark policy rate currently sits at 0.75 percent.

At 9:28 a.m. ET (1328 GMT), the Canadian dollar was

trading at C$1.2586 to the greenback, or 79.45 U.S. cents, up 0.8 percent. The currency's weakest level of the session was C$1.2691, while it touched its strongest since Aug. 4 at C$1.2575. Gains for the loonie came even as prices of oil, one of

Canada's major exports, edged lower. U.S. crude prices

were down 0.19 percent at $47.00 a barrel.

The U.S. dollar dipped against a basket of major

currencies, pressured by continuing uncertainty over the White House's ability to push through its economic agenda.

Canadian government bond prices were mixed across the yield

curve, with the two-year price flat to yield 1.231 percent and the 10-year rising 8 Canadian cents to

yield 1.838 percent. Still, the difference between the 10-year yield and its U.S. equivalent narrowed by 1.2 basis points to a spread of -33.7 basis points, as Canadian government bonds underperformed.

(Reporting by Fergal Smith; Editing by W Simon)