* C$ tracks rallying equities
* Rise overcomes effect of weak Canadian economic figures
* Bonds slip, await outcome of two-day Fed meeting (Updates to close)
By Ka Yan Ng
TORONTO, March 17 (Reuters) - The Canadian dollar firmed against the greenback on Tuesday, making a comeback after dropping early in the day on weak Canadian economic data, as the currency market's appetite for risk was sharpened by strong equity market advances.
The Canadian dollar came under pressure in the morning on news that Canadian factory sales fell sharply in January. It then moved in a wide range of C$1.2669 to C$1.2768 to the U.S. dollar, a band similar to Monday's trading range, and one that the currency has gradually shifted to since hitting a 4-1/2 year low a week ago.
The gains have come largely on the back of six straight higher closes on the Toronto Stock Exchange, and corresponding optimism in U.S. stocks.
"If anything, I think what we're seeing as we see these rallies in dollar/Canada, people are taking advantage of the situation and are getting short given that equities are still fairly firm and levels of risk aversion are declining," said George Davis, chief FX technical analyst at RBC Capital Markets.
The Canadian dollar finished at C$1.2688 to the U.S. dollar, or 78.81 U.S. cents, up from C$1.2735 to the U.S. dollar, or 78.52 U.S. cents, at Monday's close.
While stock market rallies have given an overall boost to the Canadian currency recently, it has also had short-lived setbacks in reaction to data that has confirmed a big slowdown in the Canadian economy.
The currency came under pressure on Tuesday as data showed factory sales tumbled 5.4 percent in January from the previous month due to the meltdown in the auto industry. The number was slightly ahead of the 5.8 percent decline expected, and followed an 8.2 percent drop in December. [ID:nN17446129]
Other data showed the labor productivity of Canadian businesses slid a sharper than expected 0.5 percent in the fourth quarter of 2008, leading to the first annual decline in productivity since 1996. [ID:nN17307691]
Canadian bond prices were lower on Tuesday as a steady climb by North American stock markets curbed the safe-haven appeal of government debt.
The unexpected jump in U.S. housing starts also offered a reason to dip into riskier assets such as stocks. Bond prices typically trade inversely to stocks.
Investors are also awaiting the outcome of the two-day U.S. Federal Reserve policy meeting that began on Tuesday. Market players are watching for what the Fed has to say about the possibility of a large-scale purchase of U.S. Treasuries to try to lower interest rates.
"There's this back and forth debate over whether the Fed will buy Treasuries or not. It seems though that the balance of predictions have tilted back to 'no' today. Again, a bond bearish outcome for government bonds, mostly for Treasuries in the U.S. but also indirectly for Canada," said Eric Lascelles, chief economics and rates strategist.
The two-year bond fell 5 Canadian cents to C$102.92 to yield 1.017 percent. The 10-year bond fell 42 Canadian cents to C$107.23 to yield 2.924 percent.
The 30-year bond lost 45 Canadian cents to C$124.05 to yield 3.630 percent. The U.S. 30-year bond yielded 3.818 percent.
Canada bonds outperformed U.S. Treasuries across most of the curve, with the 30-year yield 18.8 basis points below its U.S. counterpart, compared with 15.2 basis points on Friday. (Reporting by Ka Yan Ng; Editing by Peter Galloway)