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* Weaker greenback opens door to Canadian dollar's gain
* Talk of Fed rate cut on Tuesday key drag on U.S. dollar
* Bonds hold steady ahead of Fed interest rate decision
By Frank Pingue
TORONTO, Dec 15 (Reuters) - The Canadian dollar finished 1.6 percent higher versus its U.S. counterpart on Monday as expectations that the U.S. Federal Reserve will cut interest rates on Tuesday pushed traders to abandon the greenback.
Bond prices, with no major Canadian economic data to consider, rallied after a flat start to the session to close higher across the curve as investors dumped equities after some weak U.S. data.
The Canadian dollar closed at C$1.2317 to the U.S. dollar, or 81.19 U.S. cents, up from C$1.2512 to the U.S. dollar, or 79.92 U.S. cents, at Friday's North American session close.
After having rallied on a string of weak economic data and a dark global economic outlook, the greenback tumbled in the latest session because of a greater sense of calm on equity markets, which helped to ease extreme risk aversion.
And speculation that the Fed will lower interest rates by 50 basis points or more from 1 percent when it concludes its policy meeting on Tuesday added to the drag on the greenback.
That was enough to offset the weight on the Canadian dollar being exerted by a drop in the price of oil, a key Canadian export and one that often directs the currency.
"The Canadian dollar really is strengthening and, of course, the U.S. dollar is falling out of bed, and the Canadian dollar is just an unwitting recipient of that," said Eric Lascelles, chief economics and rates strategist at TD Securities.
"Really the (Canadian) currency is swimming upstream today when you look at oil prices and a variety of other factors out there, so ultimately you need to pin (it's rise) on the U.S. dollar's sharp move (down) today."
Oil prices rallied early in the session on expectations that the Organization of the Petroleum Exporting Countries would agree to its biggest supply cut ever when the group meets in Algeria this week.
But those gains unraveled on deepening worries that the economic slump would crimp energy demand heading into 2009.
The Canadian dollar hit a session high of C$1.2230 to the U.S. dollar, or 81.77 U.S. cents, just before midday, when oil prices turned lower.
WEAK DATA BOOSTS BONDS
Canadian bond prices followed the U.S. Treasury market to a higher close as data from the United States pointed to a weak economy and lured investors into safe-haven government debt.
The latest data from the United States showed manufacturing taking another hit, while price declines provided a reminder that deflation may be on the horizon.
"We sort of rallied a little bit as we've seen equity markets come off," said Mark Chandler, fixed income strategist at RBC Capital Markets. "There was no (key) data out in Canada today, but the U.S. data was roughly in line with expectations, which means soft."
Canada's economic calendar will pick up as the week goes on with the key reports being October retail sales figures due out Thursday, and Friday's consumer prices report for November, which is expected to show another drop in prices.
The two-year bond rose 5 Canadian cents to C$102.48 to yield 1.459 percent. The 10-year rallied 20 Canadian cents to C$109.65 to yield 3.066 percent.
The yield spread between the two-year and 10-year bond was at 161 basis points, up from 158 basis points at the previous close.
The 30-year bond rose 22 Canadian cents to C$121.75 to yield 3.750 percent. In the United States, the 30-year Treasury yielded 2.964 percent. (Editing by Peter Galloway)