* Canadian dollar at C$1.2578, or 79.50 U.S. cents
* Bond prices mixed across the yield curve
* Canadian yields fall further below U.S. yields
TORONTO, Oct 20 (Reuters) - The Canadian dollar weakened against its U.S. counterpart on Friday, pressured by data showing a surprise drop in domestic retail sales and as the greenback broadly gained. Retail sales fell by 0.3 percent in August from July, with lower sales at food, building supplies and home furnishing retailers. Analysts had forecast an increase of 0.5 percent.
"That suggests there is a little more deceleration in the economy than the market expected," said Andrew Kelvin, senior rates strategist at TD Securities. "It does support recent price action which has seen markets price in a smaller and smaller chance of (further) tightening from the Bank of Canada this year." Chances of another interest rate increase this year fell to less than 50 percent from 57 percent before the data, while the probability of a hike as soon as next week slipped to less than 20 percent, the overnight index swaps market indicated.
The central bank will make an rate decision on Wednesday. It hiked in July and September, the first rate increases since 2010, after rapid expansion in the domestic economy in the first half of the year. But economists expect growth to slow in the second half of the year, and separate data on Friday showed that inflation remains well below the central bank's 2 percent target. The annual inflation rate increased to 1.6 percent in September from 1.4 percent in August, matching forecasts.
The U.S. dollar rose as progress on a U.S. tax
overhaul raised prospects of a fiscal boost to the economy.
At 9:21 a.m. ET (1321 GMT), the Canadian dollar was
trading at C$1.2578 to the greenback, or 79.50 U.S. cents, down 0.7 percent. The currency traded in a range of C$1.2477 to C$1.2582. Lower prices for oil, one of Canada's major exports, added to pressure on the loonie.
U.S. crude prices were down 0.57 percent at $51.00 a
barrel, as investors booked profits despite tensions in the Middle East that have slashed supplies of crude. Canadian government bond prices were mixed across a steeper
yield curve, with the two-year up 5 Canadian cents to yield 1.46 percent and the 10-year falling 6
Canadian cents to yield 2.021 percent. Canadian yields fell further below yields on U.S. debt. The 10-year spread widened 4.5 basis points to a spread of -35.3 basis points, its biggest gap since Aug. 16.
(Reporting by Fergal Smith; Editing by Meredith Mazzilli)