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CANADA FX DEBT-C$ notches 5-month high as oil rallies, greenback slides

* Canadian dollar rises 0.9% against the greenback

* Loonie touches its strongest since Jan. 3 at 1.3151

* Price of oil increases 4.6%

* Canada-U.S. 2-year spread at narrowest since February 2018

TORONTO, June 20 (Reuters) - The Canadian dollar strengthened to a five-month high against its U.S. counterpart on Thursday as oil prices climbed and the greenback was pressured by the prospect of interest rate cuts by the Federal Reserve.

The U.S. dollar sank against a basket of currencies

and is on track for its biggest two-day drop in a year after the Fed signaled it was ready to cut interest rates as early as next month. The price of oil, one of Canada's major exports, jumped after Iran shot down a U.S. military drone, raising fears of a military confrontation between Tehran and Washington. U.S. crude

oil futures were up 4.6% at $56.21 a barrel.At 9:38 a.m. (1338 GMT), the Canadian dollar was

trading 0.8% higher at 1.3180 to the greenback, or 75.87 U.S. cents. The currency touched its strongest intraday level since Jan. 3 at 1.3151. Canada lost 16,000 jobs in May, the first decline in three months, as hiring fell in the construction sector, according to a report from ADP. Still, data on Wednesday showing that the annual rate of Canadian inflation climbed to a seven-month high in May could help fend off interest rate cuts from the Bank of Canada.

Meanwhile, Mexican President Andres Manuel Lopez Obrador said it was now up to Canada and the United States to ratify the United States-Mexico-Canada Agreement (USMCA) after Mexico's Senate approved the trade deal on Wednesday. Canada sends about 75% of its exports to the United States, so its economy could benefit if all three countries ratify the new North American trade pact. Canadian government bond prices were mixed across a steeper

yield curve, with the two-year flat to yield 1.392percent and the 10-year falling 8 Canadian cents to

yield 1.432%. The gap between Canada's 2-year yield and its U.S. equivalent narrowed by 4.8 basis points to a spread of 32.6 basis points in favor of the U.S. bond, its smallest gap since February last year.

(Reporting by Fergal Smith Editing by Chizu Nomiyama)