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* C$ breaches key level, hits lowest point since Sept 2004
* 12.3 pct drop in Canadian housing starts hits currency
* Bonds eye flood of U.S. government debt this week (Updates to close)
By Ka Yan Ng
TORONTO, March 9 (Reuters) - The Canadian dollar fell to its lowest level versus the U.S. dollar since September 2004 on Monday after data showed a sharper than expected decline in new home construction in Canada.
The Canadian currency fell as low as C$1.3066 to the U.S. dollar, or 76.53 U.S. cents -- piercing a key level it had brushed up against several times last week -- shortly after a report said Canadian housing starts fell 12.3 percent in February.
Housing starts fell to a seasonally adjusted annualized rate of 134,600 units from 153,500 in January. [ID:nN09444629]
While the weak housing data was a major catalyst driving the currency lower, the fall also came against a backdrop of a renewal of risk aversion in the market.
"It's essentially riding the risk aversion wave downwards and the weaker than expected housing starts report didn't help," said Sal Guatieri, senior economist at BMO Capital Markets.
The Canadian currency finished at C$1.2991 to the U.S. dollar, or 76.98 U.S. cents, down from C$1.2865 to the U.S. dollar, or 77.73 U.S. cents, at Friday's close.
A new round of banking worries also washed over the market on Monday after Britain's Lloyds Banking Group (LLOY.L) became the latest big financial institution to be rescued by government [ID:nL9208557], brightening the allure of the U.S. dollar as a safe haven bet.
The Lloyds bailout rattled overseas stock markets and put pressure on North American equities despite some hope that Washington will provide more clarity on its plans to shore up the U.S. banking system.
The Canadian dollar has been linked tightly to the movements on the Toronto stock market recently, partly as a reflection of risk appetite and partly due to their common relationship to commodity prices, especially oil, a key Canadian export.
Canadian bonds were flat across most of the curve, tracking their U.S. counterparts as the market was preparing to absorb $63 billion in new U.S. government notes and bonds this week.
Some readjustment was also occurring after last week's big gains, said Sheldon Dong, fixed income analyst at TD Waterhouse Private Investment.
"A bit of a giveback is expected. I think it's a day of trading volatility more than anything else," he said.
Canadian bonds shrugged off the sharper than expected decline in domestic housing starts. The key data this week is Canadian employment statistics for February on Friday. According to analysts surveyed by Reuters, 52,500 jobs are expected to have been lost.
The two-year bond was down 1 Canadian cent at C$103.06 to yield 0.958 percent. The 10-year bond was unchanged at C$107.10 to yield 2.940 percent.
The 30-year bond lost 75 Canadian cents to C$123.75 to yield 3.645 percent. The U.S. 30-year bond yielded 3.589 percent. (Editing by Peter Galloway)