* Canadian dollar now down 21 percent in 2008
* Bond prices end lower as riskier assets back in favor
* Friday's CPI data not expected to have big impact
By Frank Pingue
TORONTO, Oct 23 (Reuters) - The Canadian dollar closed slightly lower against the U.S. dollar on Thursday but managed to rally sharply from a 4-year low touched early in the session when investors opted to liquidate riskier assets in favor of the greenback.
Domestic bond prices were stripped of their early gains and closed lower right across the curve as volatile stock markets bounced back into positive territory and left investors with little interest for government debt.
The Canadian dollar closed at C$1.2557 to the U.S. dollar, or 79.64 U.S. cents, down from C$1.2547 to the U.S. dollar, or 79.70 U.S. cents, at Wednesday's close.
Earlier, the currency fell to C$1.2740 to the U.S. dollar, or 78.49 U.S. cents, its lowest level since October 2004. That slide was blamed on investors being forced to liquidate assets rather than the usual fundamentals.
The rebound by North American equity markets to close mostly higher, after spending much of the day in negative territory, helped reverse the slew of U.S. dollar buying that had been playing havoc with the domestic currency for days.
"A bit more stability emerging in equity markets may be suggesting some easing in concerns about financial market fragility, prompting some sort of a global recession," said Paul Ferley, assistant chief economist at Royal Bank of Canada.
"Those are the factors that have been supporting the U.S. dollar in recent days so you may have got some easing there."
Still, the Canadian dollar closed lower for a fifth straight session and is down 21 percent this year following its dramatic 17.5 percent climb last year, when it rose above the U.S. dollar for the first time in more than 30 years.
The Bank of Canada said in its quarterly report on Thursday that the Canadian economy will slip to the brink of recession in late 2008 and early 2009, because of the global financial crisis, a U.S recession and lower commodity prices.
The report followed the bank's decision earlier this week to lower its key interest rate by 25 basis points to 2.25 percent and suggest that more rate cuts are on the horizon.
Bond prices ended down across the curve as a late scramble into equity markets left dealers with less of a desire to seek the safety of government debt.
After spending much of the session in negative territory, the Toronto Stock Exchange's main index closed 1 percent higher while the Dow Jones industrial average rose 2 percent.
"It seemed to weaken off after stock markets took on a better tone," said Sal Guatieri, senior economist at BMO Capital Markets.
The next Canadian data due out is the consumer price index report for September, due on Friday at 7:00 a.m. (1100 GMT), which is expected to be flat after a 0.2 percent drop in August.
But Ferley suggested it will have a muted impact on the markets as recent comments from the Bank of Canada suggest its focus on growth has pushed inflation concerns to the back burner for now.
Recent domestic data has been worse than expected and seems to support the idea of further rate cuts. Meanwhile, the latest data from the United States showed the number of workers filing new claims for jobless benefits rose more than expected.
The two-year bond dropped 5 Canadian cents to C$101.28 to yield 2.122 percent. The 10-year bond fell 23 Canadian cents to C$105.04 to yield 3.622 percent.
The yield spread between the two-year and the 10-year bond moved to 159 basis points from 154 at the previous close.
The 30-year bond slipped 20 Canadian cents to C$114.95 to yield 4.106 percent. In the United States, the 30-year treasury yielded 4.045 percent.