* Canadian dollar at C$1.2896, or 77.54 U.S. cents
* Loonie falls 0.7 percent
* Canada's inflation rate cools to 2.2 percent in April
* Bond prices higher across the yield curve
TORONTO, May 18 (Reuters) - The Canadian dollar weakened against its U.S. counterpart on Friday after weaker-than-expected domestic inflation dampened prospects of another Bank of Canada interest rate hike as early as this month.
Canada's annual inflation rate cooled modestly to 2.2 percent in April, short of economist expectations for 2.3 percent, as consumers paid less for travel services and gasoline prices moderated, data from Statistics Canada showed. two out of three of the central bank's core inflation measures rose and separate data showed that Canadian retail sales rose by the most in five months.
It fits with the Bank of Canada's view that it is going to have to raise interest rates further but "inflation isn't really pushing them to do it in a really fast way that would destabilize the household sector," said Nathan Janzen, senior economist at Royal Bank of Canada.
The central bank has raised its benchmark interest rate three times since July to leave it at 1.25 percent. Chances of another hike at the May 30 announcement sank to 35 percent from nearly 50 percent before the data. BOCWATCH
At 9:21 a.m. ET (1321 GMT), the Canadian dollar CAD=D4 was trading 0.7 percent lower at C$1.2896 to the greenback, or 77.54 U.S. cents. The currency touched its weakest since Tuesday at C$1.2909.
Declines for the loonie came as the top U.S. trade official on Thursday poured cold water on the prospect of an imminent breakthrough in talks to rework the North American Free Trade Agreement hours after Canada's prime minister struck a positive note. sends about 75 percent of its exports to the United States so its economy could benefit if a deal is reached.
The price of oil, one of Canada's major exports, edged lower after reaching on Thursday its highest in three-and-a-half years. U.S. crude CLc1 prices were down 0.2 percent at $71.34 a barrel. government bond prices were higher across the yield curve, with the two-year CA2YT=RR up 5.5 Canadian cents to yield 2.035 percent and the benchmark 10-year CA10YT=RR rising 22 Canadian cents to yield 2.494 percent.
On Thursday, the 10-year yield touched its highest in more than four years at 2.537 percent.