Sept. 12 (Bloomberg) — Canadian bond investors will avoid a bear market with the central bank likely to raise interest rates at a gradual pace as the economy strengthens, according to Pacific Investment Management Co.

Yields on 10-year government bonds will rise to a range of 3 percent to 4 percent, Ed Devlin, who manages Canadian bond funds at Pimco, the world’s largest manager of fixed-income mutual funds, wrote in a note today. The Bank of Canada will probably raise rates “sometime in 2015,” Devlin said.

“Investors should be prepared for long-term bond yields in Canada to rise over the balance of this year, and possibly next year, too,” New York-based Devlin said in the report. “We do not expect a great bear market in bonds, and we see value in 10-year yields.”

Investors can guard against rising interest rates by adding provincial debt, he wrote. “Floating-rate, high-quality bonds issued by provinces look attractive; Ontario and Quebec in particular stand to benefit from the improving economic environment.”

Bank of Canada Governor Stephen Poloz should soon end a neutral bias on his 1 percent policy interest rate, and he may do so if third-quarter economic growth exceeds a 3 percent at an annual rate, Devlin said. Poloz said on Sept. 3 there must be sustained gains in exports to trigger business investment that will take the economy to full output during the next two years.

Gathering Speed

“We see the recovery gathering speed as exports pick up,” Devlin said. Canada’s recovery will also include a mix of “bad” growth fed by gains in consumer debt and the housing market, he said. Poloz and Finance Minister Joe Oliver have expressed concern about consumer debts and rapid housing construction in Toronto and Vancouver.

Canada’s 10-year debt yield rose three basis points, or 0.03 percentage point, to 2.23 percent, according to Bloomberg Bond Trader prices. The 2.5 percent securities maturing in June 2024 lost 27 cents to C$102.38.

Devlin’s prediction for 10-year yields compares with a Bloomberg economist forecast for a rate of 3.25 percent at the end of next year and 3.41 percent at the end of March 2016.

Canada’s dollar lost 0.6 percent to C$1.1095 per U.S. dollar, reaching the weakest level since March.

Poloz will find it more difficult to weaken the currency with comments about the risk of a tepid recovery as the economy gains momentum, Devlin said.

“The objective is noble, but the problem with talking down a currency is that if the talk is not followed up by actions, the speculators who are shorting the Canadian dollar today will likely close their positions,” he said.

To contact the reporter on this story: Greg Quinn in Ottawa at gquinn1@bloomberg.net

To contact the editors responsible for this story: Dave Liedtka at dliedtka@bloomberg.net Paul Cox, Greg Storey