By Fergal Smith

TORONTO (Reuters) – The Canadian dollar strengthened for a second day against its U.S. counterpart on Tuesday as hotter-than-expected domestic inflation data spurred investors to reduce bets on another outsized interest rate cut from the Bank of Canada.

Canada’s annual inflation rate increased to 2.0% in October from 1.6% in September, eclipsing the 1.9% rate that economists had forecast, as gas prices fell less than the previous month.

“This was a relatively hotter inflation report that tentatively scaled back the probability of upsizing December’s likely rate cut but with further important developments still ahead,” Derek Holt, head of capital markets economics at Scotiabank, said in a note.

“Markets responded by putting a bid to the Canadian dollar.”

Money markets see a 23% chance the BoC would cut interest rates by half a percentage point at its next policy decision on Dec. 12, down from 38% before the data.

The BoC eased by 50 basis points in October, the first cut of that magnitude in 15 years outside of the pandemic era.

Upcoming third-quarter gross domestic product data on Nov. 29 and the November employment report on Dec. 6 could also help guide BoC easing expectations, Holt said.

The Canadian dollar was trading 0.3% higher at 1.3970 to the U.S. dollar, or 71.58 U.S. cents, extending its rebound from a 4-1/2-year low on Friday at 1.4105.

The price of oil, one of Canada’s major exports, was trading 0.2% lower at $69.01 a barrel as the restart of production at Norway’s Johan Sverdrup oilfield offset investor concerns about an escalation in the Russia-Ukraine war.

Canadian bond yields moved higher across the curve.

The 10-year was up 1.6 basis points at 3.294%, while the gap between it and the U.S. equivalent was trading 4.6 basis points narrower at roughly 109 basis points in favor of the U.S. note.

(Reporting by Fergal Smith; Editing by David Gregorio)