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UPDATE 1-CANADA FX DEBT-Loonie climbs to 3-month high on oil rally, dovish Fed

the prospect of interest rate cuts by the Federal Reserve.

Fed@

* Canadian dollar rises 0.7% against the greenback

* Loonie touches strongest level since March 1 at 1.3151

* Price of oil increases 5.4%

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

(Adds portfolio manager quotes and details throughout, updates prices) TORONTO, June 20 (Reuters) - The Canadian dollar strengthened to a three-month high against its U.S. counterpart on Thursday as oil prices surged and the greenback was pressured

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

posting its biggest two-day drop in a year a day after the Federal Reserve 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 settled 5.4% higher at $56.65 a barrel.

In addition to higher oil prices and the prospect of Fed rate cuts, the loonie has benefited from data on Wednesday showing that the annual rate of Canadian inflation climbed to a seven-month high in May. "We have got three forces at play ... all working in the same direction, pushing the Canadian dollar to very high levels," said Hosen Marjaee, a senior portfolio manager at Manulife Asset Management.

At 3:51 p.m. (1951 GMT), the Canadian dollar was

trading 0.7% higher at 1.3190 to the greenback, or 75.82 U.S. cents. The currency touched its strongest intraday level since March 1 at 1.3151. Gains for the loonie came as 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 lower across a steeper

yield curve, with the two-year down 2.5 Canadiancents to yield 1.404% and the 10-year falling 29

Canadian cents to yield 1.454%. The gap between Canada's two-year yield and its U.S. equivalent narrowed by 4 basis points to a spread of 33.6 basis points in favor of the U.S. bond, its smallest gap since February last year. 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, a human resources company.

(Reporting by Fergal Smith; Editing by Chizu Nomiyama and Peter Cooney)