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* C$ pares gain to $1.0207
* Bond prices slide as risk appetite gains
* Canada government hit with formal contempt charge
* Budget could decide fate of government (Updates to close)
By Ka Yan Ng
TORONTO, March 21 (Reuters) - The Canadian dollar CAD=D4 closed higher against the U.S. currency on Monday but off the day's high as resurgence in risk appetite around the world outgunned worries about the possibility of a spring election in Canada.
A special parliamentary committee declared Canada's minority government to be in contempt, which the market saw as a possible election trigger and a harbinger of possible market instability.
The committee, however, stopped short of trying to bring down the governing Conservatives in Parliament over the contempt finding. It ruled the government had wrongly withheld information about the cost of a program to increase the number of prison cells. [ID:nN218894]
"You're getting all these things that are lining up to be potential Canadian dollar negatives. Here's the first one," said John Curran, senior vice president at CanadianForex.
The Canadian dollar fell about 30 ticks to as low as C$0.98 as the minority Conservative government looks set to face at least two parliamentary confidence votes this week and the chances of it surviving beyond Friday are uncertain at best.
A second risk lies with Finance Minister Jim Flaherty's budget, due on Tuesday at 4 p.m. (2000 GMT). It is likely to show that Ottawa is cutting its deficit and may contain a sprinkling of targeted measures to bolster economic recovery. [ID:nN16271484]
Still, the currency was up from Friday's close, rebounding from last week's sell-off against its U.S. counterpart, bolstered by firm commodity prices and developments in strife-torn Libya and quake-stricken Japan.
It closed at C$0.9797 to the U.S. dollar, or $1.0207, up from Friday's North American finish of C$0.9861 to the U.S. dollar, or $1.0141. Earlier, it had risen as high as C$0.9750 to the U.S. dollar, or $1.0256, it highest point in almost a week.
Oil, a key driver for the commodity-linked Canadian dollar, rose following a wave of United Nations-mandated airstrikes on Libya and as unrest in the Middle East fueled worries about the region's oil supply. For more see [O/R] and [ID:nLDE72J0RL].
Concerns about a nuclear power station crisis in Japan eased somewhat, lifting market sentiment.
"Canada is doing well overall but these recent events may provide some uncertainty and weaken off Canada in the medium term," Curran said. "Longer term, Canada should outperform. We may just need to go through a few bumps in the road beforehand."
Canadian bond prices fell across the curve, in step with U.S. Treasury prices, which dipped as risk appetite improved on the Libya and Japan situations, and pushed investors towards stocks and other riskier assets. [US/]
"Those were the two things that were driving markets today globally," said Sheldon Dong, fixed income analyst at TD Waterhouse Private Investment. "It was risk-on session."
On Tuesday, well before Canada's federal budget is announced, market players will get a look at retail sales data for January to find clues on how well the Canadian economy is faring and refine expectations on when the Bank of Canada might raise interest rates for the first time this year. The leading indicator for February is also due.
Primary dealer forecasts for the timing of the bank's next rate increase were largely split between its May 31 and July 19 policy announcement dates, according to a Reuters poll last week. Market pricing, however, is currently betting on October.
The interest rate-sensitive two-year bond CA2YT=RR dropped 14 Canadian cents to yield 1.678 percent, while the 10-year bond CA10YT=RR was down 33 Canadian cents to yield 3.211 percent. (Reporting by Ka Yan Ng; editing by Peter Galloway)