July 25 (Bloomberg) -- Canada's dollar was on a pace to post its biggest weekly decline since early the first week of June after oil prices dropped and the government reported a retail sales increase that was less than forecast.

The Canadian dollar fell against 14 of the 16 most-actively traded currencies for the week, slipping 1.4 percent against its U.S. counterpart. It is the first weekly drop since July 4.

``There was no reason to buy the Canadian dollar this week,'' said David Watt, a senior currency strategist at RBC Capital Markets in Toronto, a unit of Canada's biggest bank by assets. ``We've got oil prices coming back down and soft economic numbers. It's basically a one-two punch to cause people to be more cautious about pushing the Canadian dollar through parity.''

The currency fell 1.4 percent to C$1.0202 per U.S. dollar at 2:35 p.m. in Toronto, from C$1.0057 on July 18. One Canadian dollar buys 98.02 U.S. cents. The currency fell 2.6 percent in the week ending June 6.

Crude oil prices declined 1.6 percent to $123.42 per barrel in trading on the New York Mercantile Exchange. It reached a record $147.27 per barrel on July 11. Alberta has the largest crude reserves outside the Middle East.

``You've had a little bit of softer data out of Canada, and you've had oil prices retrace,'' said Jonathan Gencher, director of foreign-exchange sales at BMO Capital Markets in Toronto, a unit of Canada's fourth-largest bank.

Commodity Index

The Bank of Canada Commodity Price Index declined for a third week from a record 318.13 on July 2, reaching 290.57 on July 23.

Retail sales rose 0.4 percent in May, compared with a 0.6 percent gain in April and a 0.6 percent median forecast of 22 economists surveyed by Bloomberg News. Statistics Canada released the report on July 22.

The yield on the two-year government bond fell 3 basis points, or 0.03 percentage point, this week to 3.14 percent. The price of the 3.75 percent security due in June 2010 rose 4 cents to C$101.08.

The Canadian dollar will weaken to C$1.07 in the first quarter of 2009, according to the median estimate of 31 economists surveyed by Bloomberg News.

Watt said a decline in commodity prices will cause the Canadian dollar to weaken to C$1.06 at year-end.

``We expect the commodities prices to come off, and oil prices to come off further,'' Watt said. ``We expect the economic downturn in the U.S. will have a negative impact on Canada, and the domestic economy in Canada will show some slowdown as a result of that. We expect the U.S. dollar to recover.''

Federal Reserve

If the Federal Reserve increases its overnight lending rate, the Bank of Canada will also increase its rate to control inflation, according to a report today by CIBC World Market economists Avery Shenfeld and Krishen Rangasamy in Toronto.

``The upside surprise to Canadian short rates, coupled with a rebound in energy prices in 2009, should see the Canadian dollar break more decisively through parity,'' the economists wrote. ``That said, its gains will be constrained by ongoing woes in the factory sector that cast doubt on the economy's ability to live with a much firmer exchange rate.''

Traders increased bets the Fed will raise its 2 percent benchmark rate at its Sept. 16 meeting. Futures contracts on the Chicago Board of Trade showed a 43 percent chance the central bank will increase the target rate for overnight bank lending by at least a quarter-percentage point, from 41 percent odds yesterday.

Shenfeld forecast the Canadian dollar won't be sensitive to commodity prices and will appreciate by year-end to 97 Canadian cents per U.S. dollar.

Lending Rate

The central bank kept its overnight lending rate at 3 percent on July 15 for a second meeting, after lowering borrowing costs four times beginning in December.

The Bank of Canada will meet again on Sept. 3. Gencher said he does not anticipate a rate change then.

``It's on hold for the next while,'' Gencher said. ``Inflation is still a big concern for every central bank, but as long as you can get a moderation on inflation pressure, whether that's from oil prices coming back or something else, there is still enough growth concern that I don't see the bank doing much either way.''

The 10-year bond yield rose 4 basis points this week to 3.84 percent, from 3.8 percent on July 18.

Bond Yield

The 10-year bond yielded 70 basis points more than the two- year security, rising from 63 basis points on July 18.

Canada's two-year bond yield will rise to 3.27 percent by the end of this year, with the 10-year yield increasing to 3.83 percent, according to the median forecast in a Bloomberg survey.

The U.S. 10-year Treasury note yielded 25 basis points more than the comparable-maturity Canadian bond, decreasing from 28 basis points a week ago.

Canadian government bonds have returned 3.0 percent this year. U.S. Treasuries have returned 2.3 percent in 2008, according to Merrill Lynch & Co. index statistics.

To contact the reporter on this story: Jamie McGee in New York at jmcgee8@bloomberg.net

Last Updated: July 25, 2008 14:48 EDT