Oct. 9 (Bloomberg) -- Canada’s jobless rate unexpectedly fell last month, signaling that the U.S.’s largest trading partner has begun an economic recovery that may lead the central bank to increase interest rates within the next year.

Employment rose by 30,600, six times more than forecast, on new jobs in construction and government, Statistics Canada said today. The jobless rate fell to 8.4 percent from 8.7 percent in August.

The Canadian dollar and yields on 2-year government bonds rose to their highest levels this year as investors increased bets the Bank of Canada may follow Australia and withdraw some economic stimulus by raising borrowing costs.

“The risks of them going sooner rather than later are increasing at the moment,” said Shaun Osborne, chief currency strategist at TD Securities Inc. in Toronto, adding he still expects the bank will wait until the middle of next year to raise borrowing costs.

The central bank lowered its benchmark lending rate to 0.25 percent in April and pledged to keep it there through June 2010 unless the inflation outlook changes materially. The lower rates have eased credit conditions for businesses, and made it cheaper for households to take out loans and purchase homes.

The bank released a survey today that showed businesses are the most optimistic about future sales since at least 1998.

Faster Recovery

Because of Canada’s healthier banks, policy makers have claimed stimulus in Canada will be more effective than in other major economies. None of Canada’s 21 banks has received government funding since credit seized up worldwide in August 2007, prompting government officials and organizations like the International Monetary Fund to predict the country will emerge from the global recession at a faster pace than other major economies.

The latest positive data include a 7.2 percent rise in August building permits, a pick-up in factory sales, a larger than expected increase in spending by purchasing managers last month, and a third consecutive monthly increase in home prices, according to the July reading of the Teranet-National Bank price index.

The Canadian dollar appreciated 0.8 percent to C$1.0435 per U.S. dollar at 4:33 p.m. in Toronto, from C$1.0518 yesterday. It touched C$1.0411, the strongest since Sept. 29, 2008.

The yield on Canada’s overnight index swap due in one year, a security based on investor expectations of where the Bank of Canada’s rate will be at that point, rose above 0.6 percent today for the first time since February, trading as high as 0.64 percent. The yield on 9-month swaps rose to as high as 0.45 percent today from 0.39 percent yesterday.

Bond Yields Rising

The yield on Canadian government bonds maturing in December 2011 rose to 1.70 percent today, gaining more than one-third of a percentage point from 1.36 since Monday.

Royal Bank of Canada, the country’s biggest lender, today raised its fixed-rate mortgages by as much as 0.35 percentage points.

“The market is starting to speculate whether the Bank of Canada will raise interest rates sooner than it conditionally pledged,” said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto. “We still think that the bank will not tighten until July next year, but the risks are more evenly balanced now.”

This week, Australia became the first country in the Group of 20 nations to boost borrowing costs since the start of the credit crisis. The Reserve Bank of Australia increased the overnight cash rate target on Oct. 6 to 3.25 percent from a 49- year low of 3 percent.

Not Australia

“The Bank of Canada is not like the Reserve Bank of Australia,” Derek Holt, an economist at Scotia Capital in Toronto, said in an interview on Bloomberg Television. “The Canadian growth dynamics are very different. We’re much more pointed south to weakness in the U.S. economy.”

While Canada, like Australia, is a major commodity exporter and is benefiting from rising prices for raw materials, roughly three-quarters of the country’s foreign sales are shipped to the lagging U.S. economy. A stronger Canadian dollar, which has advanced 17 percent against its U.S. counterpart this year, is also damping demand for exports.

Statistics Canada said separately today the country’s trade deficit widened to a record C$1.99 billion ($1.9 billion) in August as exports plunged 5.1 percent.

Canadian government officials have sought to damp optimism of a recovery, saying that it is being driven by government stimulus and that private-sector demand remains weak.

U.S. Concern

The public sector, along with manufacturing and construction, led the rise in September employment. Government entities added 36,400 jobs during the month while construction, benefiting from rising home prices and a government stimulus package that targets the industry, added 24,600 jobs during the month.

“My big concern remains the U.S.,” Prime Minister Stephen Harper said today at a press conference in Welland, Ontario. “Even though we’ve had some good jobs news today, we aren’t out of the woods yet.”

Canadian federal and provincial governments are injecting C$61 billion in stimulus over two years to fuel infrastructure spending, boost job benefits and provide tax cuts to households that make home renovations.

To contact the reporters on this story: Theophilos Argitis in Ottawa at targitis@bloomberg.net; Chris Fournier in Montreal at cfournier3@bloomberg.net.

Last Updated: October 9, 2009 16:51 EDT