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CANADA FX DEBT-Loonie rallies as investors dial back October rate cut bets

Fergal Smith

(Adds strategist quotes and details throughout; updates prices)

* Canadian dollar rises 0.4% against the greenback

* Bank of Canada leaves benchmark rate on hold at 1.75%

* Canada posts a C$1.12 billion trade deficit in July

* Canada-U.S. 2-year spread hits narrowest since October 2017

TORONTO, Sept 4 (Reuters) - The Canadian dollar strengthened against the greenback on Wednesday as expectations fell for a Bank of Canada interest rate cut over the coming months after the central bank, in a policy announcement, made no mention of future moves. The Bank of Canada held its benchmark interest rate at 1.75% as expected but said the escalating U.S.-China trade war was doing more damage to the global economy than it had forecast in July. "They haven't pigeon-holed themselves into an October cut, and referenced the deterioration (in the world trade outlook) but also heavily stressed the fact that the Canadian economy has exceeded expectations in the last few months," said Simon Harvey, FX market analyst for Monex Europe and Monex Canada. "This is why the loonie is rallying." Chances of an interest rate cut in October fell to about 50% from nearly 70% before the announcement, data from the overnight index swaps market showed. Canada's economy expanded at a surprisingly strong annualized rate of 3.7% in the second quarter, a pace much higher than the Bank of Canada had predicted, thanks to a resurgence in goods exports. But data on Wednesday showed that Canada's trade deficit was wider-than-expected at C$1.12 billion in July, a sign that the boost to the domestic economy from trade in the second quarter may not be repeated.

At 10:36 a.m. (1436 GMT), the Canadian dollar was

trading 0.4% higher at 1.3290 to the greenback, or 75.24 U.S. cents. The currency, which hit on Tuesday its weakest intraday level in two-and-a-half months at 1.3382, traded in a range of 1.3268 to 1.3343. Gains for the loonie came as the price of oil, one of Canada's major exports, was boosted by a wider market pickup on positive news from China's services sector, after three days of losses due to fears about a weakening global economy.

U.S. crude prices were up 3.6% at $55.87 a barrel.

Canadian government bond prices were lower across the yield

curve, with the two-year down 1.5 Canadian cents toyield 1.324% and the 10-year falling 13 Canadian

cents to yield 1.128%. The gap between Canada's 2-year yield and its U.S. equivalent narrowed by 1.4 basis points to a spread of -13.2 basis points, its narrowest gap since October 2017.

(Reporting by Fergal Smith; Editing by Steve Orlofsky and David Gregorio)