* C$ drops to 94.88 U.S. cents
* Bank of Canada first in G7 to hike rates after recession
* Euro zone fears push bond prices up (Updates to close)
By Ka Yan Ng
TORONTO, June 1 (Reuters) - The Canadian dollar fell against the U.S. dollar on Tuesday, hit by global economic fears and the failure of the Bank of Canada to provide a clear signal that more interest rate increases were in the works after it raised its key rate by a quarter point.
The Bank of Canada became on Tuesday the first Group of Seven central bank to raise interest rates since the financial crisis began, pulling up its benchmark overnight rate to 0.50 percent, a move highly anticipated by the market.
But the central bank gave no indication that more hikes were on the way, causing the Canadian dollar to slump. [ID:nN01103957] [ID:nN01264788]
Currencies usually strengthen as interest rates rise as higher rates attract capital flows.
The Canadian dollar CAD=D4 finished at C$1.0540 to the U.S. dollar, or 94.88 U.S. cents, down from Monday's close of C$1.0435 to the U.S. dollar, or 95.83 U.S. cents.
"The currency was priced for a hike, so the market wasn't disappointed from that perspective. Quite simply it was the accompanying guidance that was somewhat more dovish than expected," said Jack Spitz, managing director of foreign exchange at National Bank Financial.
"Much of the volatility in the Canadian dollar has come on the back of global factors again."
Global risk sentiment was hit by a warning from the European Central Bank on European Union public finances, which overcame support provided by better-than-expected U.S. April construction and May manufacturing data. [MKTS/GLOB] [ID:nN01112488] [ID:nLAG006303]
Pressure from oil prices, which fell nearly 2 percent to below $73 per barrel on worries about Chinese and European demand, made sure the commodity-linked currency stayed on the negative side of break-even at the end of the day.
Canadian bond prices were higher across the yield curve due to strong risk aversion in markets and uncertainty about the Bank of Canada's interest-rates path.
Most of Canada's primary securities dealers, however, maintained their interest rate forecasts for 2010 even though the Bank of Canada warned against betting that it would embark on an uninterrupted campaign of rate increases. [ID:nN01126499]
All but one of 12 dealers forecast 25 basis point rate increases in July, September and October. The majority also saw a 1.50 percent year-end rate, implying a quarter-percentage point rate rise at each of the bank's four remaining policy-setting dates.
"This is the main forecast but, of course, we see the possibility to have a pause depending on the uncertainty in the world markets," said Benoit Durocher, senior economist at Desjardins Economics.
The forecast for a rate increase in July is in line with market expectations as reflected in yields on overnight index swaps, which suggest there is about 66 percent chance of a 25 basis point hike at the bank's next announcement date. BOCWATCH
The two-year Canadian government bond CA2YT=RR jumped 31 Canadian cents to yield 1.702 percent, and the 10-year bond CA10YT=RR gained 60 Canadian cents to yield 3.284 percent.
The Canadian two-year bond was 106 basis points above the U.S. two-year yield, compared with 93.2 basis points on Monday.
In new issue offerings, the province of Ontario said it plans to sell C$600 million in bonds maturing in 2039. [ID:nN01108239] (Reporting by Ka Yan Ng; editing by Peter Galloway)