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TORONTO (Reuters) - The Canadian dollar rose against the U.S. dollar on Tuesday, after an emergency interest rate cut by the U.S. Federal Reserve, followed by a smaller cut by the Bank of Canada, put the interest rate spread in Canada's favor and eased fears about the U.S. economic slowdown.
Domestic bond prices fell after the Bank of Canada delivered a smaller cut than many expected and as investors looked towards the rallying Toronto Stock Exchange.
The Canadian unit closed at C$1.0281 to the U.S. dollar, or 97.27 U.S. cents, up from C$1.0329 to the U.S. dollar, or 96.81 U.S. cents at Monday's close.
The Canadian dollar, which had fallen as low as C$1.0369 to the U.S. dollar, or 96.44 U.S. cents, climbed as high as C$1.0208 to the U.S. dollar, or 97.96 U.S. cents, after the central bank announcements.
The Fed started the ball rolling with a 75-basis-point emergency cut to the fed funds rate to 3.50 percent.
That sent the Canadian dollar lower as many analysts expected a similarly aggressive cut, of 50 basis points, by the Bank of Canada at its scheduled monetary policy announcement.
However, the Bank of Canada eased its key lending rate by just 25 basis points, to 4.00 percent, sending the currency higher on the rate differential.
Equity markets reacted favorably to the economic stimulus, with the Dow Jones Industrial average erasing much of its earlier losses, and the TSX soaring more than 500 points.
That furthered the bid for the Canadian dollar.
One of the drags on the currency as of late has come from fears that a global economic slowdown would cut demand for the commodities that Canada produces.
"Right now a lot of people are using equity markets as a barometer on the economy, especially in the context of the fallout from the subprime mortgage mess and just a general contraction in liquidity and the availability of credit," said George Davis, chief technical strategist at RBC Capital Markets.
"If we can see equity markets stabilize and rally a little bit, similar to what we saw today, then I think over the short term that would be beneficial to the Canadian dollar."
Canadian bond prices handed back all of their early gains as equities rallied and the Bank of Canada rate cut fell short of the 50-basis-point cut that some market players expected.
The increase of 0.7 percent in Canadian retail sales in November, also released on Tuesday, had no impact on the markets although the result was better than the 0.2 percent gain expected by economists.
The two-year bond was down 2 Canadian cents at C$102.04 to yield 3.105 percent. The 10-year bond dropped 40 Canadian cents to C$101.59 to yield 3.796 percent.
The yield spread between the two-year and 10-year bond was 69.1 basis points, up from 65.2 points at the previous close.
The 30-year bond decreased C$1.26 to C$114.64 to yield 4.134 percent. In the United States, the 30-year Treasury yielded 4.198 percent.
The three-month when-issued T-bill yielded 3.45 percent, unchanged from the previous close.
Editing by Renato Andrade