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Loonie closes sharply higher on stronger inflation data

Canadian dollars.

JONATHAN HAYWARD/THE CANADIAN PRESS

The loonie rose more than half a cent Friday as the pace of inflation picked up last month and raised the possibility that the Bank of Canada may move to raise interest rates more quickly than first thought.

The Canadian dollar jumped 0.61 of a cent to end at 93.01 cents (U.S.).

Statistics Canada said the annual pace of inflation rose to 2.3 per cent in May, bumped up by higher energy prices. It is the first time it's surpassed the central bank's 2 per cent target in more than two years.

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The emerging view among analysts is that while there is little danger of runaway inflation, the risk of low inflation is largely gone given the continuing strength in oil prices and expectations of a growing economy in the U.S. and Canada.

Mark Chandler, head of Canadian fixed income and currency strategy at RBC Dominion Securities, said the loonie's strength is coming from the increased possibility that the factors the Bank of Canada was citing as a cause for rising inflation may not be as temporary as the central bank thought.

If that's the case, there's a greater chance that the Bank of Canada may move to raise rates to offset inflation. However, most economists still think such a hike won't come until mid-2015.

Core inflation, which excludes temporary volatility in categories like oil, rose three-tenths of a point to 1.7 per cent – still below the bank's ideal target of 2.0 per cent and within its target range of between 1.0 and 3.0 per cent.

Lower interest rates have kept the Canadian dollar lower and helped the country's export sales.

Chandler said the Canadian dollar has also been supported by higher oil prices derived from the geopolitical instability in Iraq.

Continued uncertainty in the Middle East, along with growing tensions between Russia and Ukraine, have raised concerns that the world's oil supplies may be put at risk. The August crude contract advanced 78 cents to $106.83 a barrel.

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Sunni extremists in Iraq recently seized a number of areas in the northern part of the country, including its second-largest city, Mosul, a key gateway for oil exports. The militants have spent the past two days trying to take over the country's largest oil refinery.

But Chandler said that although the loonie is currently on an upward trajectory, it can easily be thrown off by a number of factors, including a stronger U.S. dollar.

That's a real possibility, as the U.S. continues to show signs of a steadily growing economy.

The U.S. Labour Department reported Friday that employers added 217,000 jobs in May, the fourth successive month of gains above 200,000, the first such stretch since 1999. The unemployment rate remained at 6.3 per cent, matching a five-year low.

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