Dec. 5 (Bloomberg) -- Canada's dollar fell to a 2-1/2-month low on speculation the global economy will slow, leading the nation's central bank to cut interest rates again.

The currency dropped a fifth day, after the Bank of Canada unexpectedly reduced its target rate a quarter-percentage point to 4.25 percent yesterday, citing ``difficulties'' caused by the U.S. subprime mortgage market collapse. Goldman Sachs Group Inc. said the world economy will soon ``recouple'' with the U.S. after appearing immune to its slowdown this year.

``Canada is vulnerable to the global growth slowdown,'' said Camilla Sutton, co-head of currency strategy at Scotia Capital Inc. in Toronto. ``The U.S. is ahead of the cycle and global players will follow. This is an environment where the Canadian dollar should weaken a little bit.''

Canada's dollar fell 0.3 percent to C$1.0123 per U.S. dollar at 5:01 p.m. in Toronto and touched the lowest since Sept. 18. The currency has dropped almost 12 percent from an all-time high of 90.58 Canadian cents per U.S. dollar on Nov. 7. Against the euro, it traded at C$1.4791, from C$1.4913 yesterday.

The currency remained lower after Mark Carney, who will replace David Dodge as Bank of Canada governor on Feb. 1, said while he's ``well aware'' of manufacturing struggles after the currency's 15 percent gain this year, fixing the Canadian dollar to its U.S. counterpart would be ``a mistake.''

Carney, during testimony to the House of Commons finance committee in Ottawa, also promised to stick with current policies of a floating currency and a 2 percent inflation target.

The Canadian dollar pared early losses as local companies bought the currency when it dropped below C$1.02 per dollar and C$1.50 per euro, said Jack Spitz, director of currency trading at National Bank of Canada in Toronto.

Currency Hedge

``A long list of companies are buying the Canadian dollar to hedge the currency risk at the levels that haven't been seen for a while,'' Spitz said.

The currency also rebounded from lows after reports showing increased productivity and faster-than-expected jobs growth in the U.S. eased concerns about a Canadian spillover from a U.S. slowdown.

UBS AG, Europe's largest bank by assets, today lowered its forecast for the Canadian dollar, citing lower interest rates, weaker commodity prices and decreasing mergers and acquisitions involving Canadian companies.

The Canadian dollar will decline to C$1.05 in a month, and remain there within three months, Zurich, Switzerland-based UBS said in a research note. The bank previously expected the currency to trade at 98 cents during the period.

UBS Forecast

The Bank of Canada will cut its benchmark borrowing cost to 4 percent during the first quarter, according to the UBS report. Fourteen of 16 economists surveyed by Bloomberg yesterday said the bank will lower the rate to 4 percent at its next policy meeting, on Jan. 22.

``Softening commodity prices along with a weakening M&A pipeline amid an economic slowdown does not bode well for the Canadian dollar,'' Benedikt Germanier, a currency strategist at UBS in Stamford, Connecticut, wrote in the report.

Crude oil for January delivery fell 86 cents, or 1 percent, to $87.46 a barrel at the close of floor trading on the New York Mercantile Exchange. Futures reached $99.29 on Nov. 21, the highest since trading began in 1983. Commodities, such as oil and gold, account for half of the country's exports.

The Canada's currency touched a low of C$1.0215, following the declines in higher-yielding currencies such as the British pound and Australian dollar.

`Genuine Fear'

The pound slid to the lowest in more than four years against the euro as a report showing house prices slumped last month fueled speculation policy makers will cut interest rates from 5.75 percent tomorrow. The Australian dollar fell to a one- week low after the Reserve Bank of Australia said credit-market turmoil may help contain inflation and slow global economic growth.

``There's genuine fear that the global economy will slow down significantly because of the credit crunch,'' said Shaun Osborne, chief currency strategist at TD Securities in Toronto. ``Global central banks are rolling back monetary policies, hurting all high-yielders. Some indicators suggest the Canadian dollar has a significant impact on its economy.''

Fallout from the U.S. housing slump is spreading to Canada, triggering a surge in credit costs. The cost of borrowing the Canadian dollar for three months yesterday rose to 5.11 percent, the highest since September. It fell back to 4.94 percent today.

`Spillover'

``The spillover of the financial turmoil and tightening credit markets are weighing on the Canadian currency,'' said David Watt, a senior currency strategist at RBC Capital Markets in Toronto.

The yield on two-year government debt rose 6 basis points, or 0.06 percentage point, to 3.55 percent. That was 63 basis points higher than same-maturity U.S. Treasuries, narrowing from a three-year high of 72 basis points reached on Dec. 3.

The price of the 4.25 percent Canadian security maturing in December 2009 fell 12 cents to C$101.33. Bond yields move inversely to price.

To contact the reporter on this story: Ye Xie in New York at Yxie6@bloomberg.net

Last Updated: December 5, 2007 17:12 EST