TORONTO, Sept 2 (Reuters) - The Canadian dollar rebounded from nearly a three-week low against its U.S. counterpart on Wednesday as investors raised bets on a Bank of Canada interest rate hike in the coming months after the central bank said upside risks to inflation have increased.
The loonie was trading 0.4% higher at 1.3840 per U.S. dollar, or 72.25 U.S. cents, after earlier touching its weakest level since August 13 at 1.3939.
The Bank of Canada kept its key policy rate on hold at 2.25%, as widely expected, but Governor Tiff Macklem said policymakers were prepared to raise borrowing costs multiple times if inflation remained too high.
"The BoC’s emphasis on upside inflation risks from energy price pass-through caught the market off-guard," Jason Daw and Simon Deeley, strategists at RBC Capital Markets, said in a note.
"We view today’s communications as moving them to a meeting-by-meeting basis, meaning that all meetings are live."
Investors see a 44% chance of a quarter-point rate hike next month, up from 24% before the policy announcement, and have fully priced in a move by year-end.
Canadian trade and employment data, due on Thursday and Friday, respectively, can offer further clues on the outlook for the domestic economy.
The price of oil, one of Canada's major exports, rose on renewed military strikes between the U.S. and Iran that have restricted world oil supply. U.S. crude oil futures settled 0.9% higher at $91.01 a barrel.
Canadian government bond yields moved higher across the curve. The 2-year was up 9.6 basis points at 3.115%, its highest level since March 23.
The gap between the 2-year yield and the U.S. equivalent narrowed by 10.4 basis points to about 127 basis points in favor of the U.S. note, reversing some recent widening in the gap.
Reporting by Fergal Smith; Editing by Paul Simao and Nick Zieminski
