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TORONTO (Reuters) - The Canadian dollar edged slightly lower against its U.S. counterpart on Tuesday as U.S. manufacturing data showed the economy of Canada's largest trading partner continues to struggle, disappointing investors ahead of several events later in the week that have the potential to move the market.
The U.S. data, which also weighed on North American stock markets, overshadowed Tuesday's election in the province of Quebec in which the separatist Parti Quebecois is expected to return to power.
The figures showed U.S. manufacturing shrank at its sharpest clip in more than three years last month, while separate data showed exports and hiring in the sector slumped.
"The data was soft. But the data pales in comparison with the rest of the week's events in (terms of) data risk," said Jack Spitz, managing director of foreign exchange at National Bank Financial.
On Wednesday, the Bank of Canada will announce its next interest rate decision, while Canada and the United States will release employment data for August on Friday.
The central bank is expected to leave interest rates unchanged, so investors are focused on whether Governor Mark Carney will change the bank's recent message that interest rates need to rise.
"I think (Carney's) going to be cognizant of the strength in Canadian dollar as being an economic headwind and ultimately his guidance, while hawkish, will likely acknowledge the strength of the Canadian dollar and that itself may mitigate some of the gains by loonie going forward," Spitz said.
Analysts said the impact of the Quebec election was small, partly because Parti Quebecois is expected to form a minority government, which would make it more difficult for it to hold a referendum on separation from Canada.
"Surprisingly enough, very few people are talking about that ... I thought it might have more of an impact, but it seems like the market is very complacent about it," said David Bradley, director of foreign exchange trading at Scotiabank.
The Canadian dollar finished the North American session at C$0.9858 versus the U.S. dollar, or $1.0144, marginally weaker than Friday's close of C$0.9857, or $1.0145.
Earlier in the day, it touched C$0.9843, or $1.0160, matching the high of last week, which was also the strongest level since May.
Spitz said the move to that level saw more investors stepping to sell the Canadian dollar, squaring short positions against the U.S. currency.
Canada's dollar was stronger against most other major currencies on Tuesday and touched a three-month high against the Australian dollar, even though the Australian currency got a boost after the Reserve Bank of Australia gave no indication it would cut interest rates soon.
Overall, trading ranges remained tight and volatility for the currency was low. Analysts noted Canada's dollar will take its cue from key events every day for the remainder of the week.
The European Central Bank is expected to unveil steps on Thursday to deal with the region's debt crisis, including a bond-buying scheme to help lower Spanish and Italian borrowing costs.
"There are expectations -- big expectations -- in terms of what (ECB President Mario) Draghi will deliver. He appears to have telegraphed at least some of it with respect to bond buying," Spitz said. "Anything that falls short will be traded accordingly."
Canadian government bonds were firmer across the curve, with the two-year bond climbing 5 Canadian cents to yield 1.125 percent. The benchmark 10-year bond price rose 33 Canadian cents, to yield 1.740.
Editing by Jeffrey Hodgson; Editing by Peter Galloway