April 29 (Bloomberg) -- Canada's dollar posted its biggest monthly gain since at least 1971 on prospects the Bank of Canada will keep raising borrowing costs to prevent the economy from overheating.

The currency reached the highest in 28 years yesterday. The central bank raised its benchmark interest rate to 4 percent April 25 and said a modest increase ``may be required,'' as Canada's economy is operating at or above capacity. The bank has lifted the rate six times since September and will meet again to set rates on May 24. The 10-year government bonds had the biggest monthly decline in two years.

``We see another 25 basis-point rate hike next month,'' said Ted Gould, a currency trader at Investors Bank & Trust in Boston. ``The central bank seems to be a little bit concerned the economy may be growing too fast. The Canadian dollar will continue to do well.''

Canada's dollar gained 4.8 percent this month, the most since at least February 1971, the earliest monthly data available on the Bloomberg system, to 89.55 U.S. cents from 85.41 U.S. cents a month ago. One U.S. dollar buys C$1.1168. Canada's dollar touched 89.56 U.S. cents yesterday, the highest since 89.77 U.S. cents on May 26, 1978.

The Canadian dollar has increased 4.2 percent against its U.S. counterpart this year, following four straight annual gains.

`Above Capacity'

The Canadian economy ``is projected to operate slightly above its capacity through 2006 and to return to capacity by the end of 2008,'' the Ottawa-based central bank said yesterday in its monetary policy report. ``Some modest further increase in the policy interest rate may be required.''

The central bank has raised the rate by 1.5 percentage points since September, the most since 1998, narrowing the gap with the 4.75 percent U.S. benchmark rate. Higher rates can draw investors to the nation's financial assets.

``With the central bank continuing to signal rate hikes, the Canadian dollar will continue to do well,'' said Linda Jespersen, managing director of currency trading at National Financial Bank in Toronto. ``The economy is still growing very strong and the central bank sounds hawkish. This definitely favors the Canadian dollar.''

Jespersen predicted the Canadian dollar will strengthen to C$1.1111, or 90 U.S. cents, in the next three months.

The Canadian government said yesterday gross domestic product grew 0.2 percent in February, matching the growth rate in January and the median forecast of 20 economists polled by Bloomberg. GDP is the broadest measure of all goods and services produced in Canada.

Parity

Canada's surging dollar also reflects a booming economy that is benefiting from record prices for oil, natural gas and metals like copper and gold. Canada's oil sands in Alberta contain the largest crude deposits outside the Middle East, and the country is the world's No. 2 producer of nickel and zinc.

Canada's dollar will continue to gain and may soon reach parity with its U.S. counterpart, said Dennis Gartman, an economist and editor of the Suffolk, Virginia-based Gartman Letter. The last time the Canadian currency reached parity with the U.S. dollar was 1976.

``Why shouldn't Canada go to parity? It has what the world needs. It has water, it has oil, it has steel,'' Gartman said. ``Buy the Canadian dollar.''

Commodities account for 35 percent of Canada's exports and about 10 percent of its C$1.09 trillion ($966 billion) economy, the world's eighth largest.

Bonds Slump

The yield on Canada's 10-year bond climbed 26 basis points this month, the most since a 41.6 basis point rise in April 2004, to 4.47 percent. The yield touched 4.55 percent this week, the highest since 4.554 percent on Nov. 22, 2004. The price of the 4.5 percent bond due June 2015 declined about C$2 to C$100.23. Yields move inversely to bond prices.

The yield on Canada's two-year bond increased about 18 basis points this month to 4.13 percent. The yield reached 4.21 percent this week, the highest since June 2002. The price of the 3.75 percent bond due June 2008 fell 33 cents to C$99.25.

Investors who bought Canadian government bonds at the start of the year and held them through April 27 lost 2.1 percent, including reinvested interest, compared with a 1.7 percent loss for U.S. Treasuries, according to Merrill Lynch & Co. data.

To contact the reporter on this story: Min Zeng in New York at mzeng2@bloomberg.net.

Last Updated: April 29, 2006 07:53 EDT