(Corrects to remove reference to commentary on Europe in 7th paragraph)
* C$ at C$0.9926 versus the US$, or $1.0075
* Bank of Canada largely holds to hawkish line on rates
* Global growth fears erase early C$ rally
By Alastair Sharp
TORONTO, Oct 23 (Reuters) - The Canadian dollar held steady versus the U.S. currency while short-term debt prices fell on Tuesday after the Bank of Canada surprised markets by largely retaining its hawkish view that interest rates should be raised over time.
The central bank, highlighting soaring household debt, repeated much of the rate-hike language that has made it an outlier among major economies, while making the time frame for rate hikes less definite.
The Canadian dollar had weakened after Governor Mark Carney omitted reference to the central bank's tightening bias in a speech a week ago.
"Obviously they kept the hawkish bias, which I think took the markets by surprise, so we've had a rally in the Canadian dollar," said Camilla Sutton, chief currency strategist at Scotiabank.
The currency traded as strong as C$0.9901 to the greenback, or $1.0099, after the central bank statement, from C$0.9970 just before.
But by midday it had weakened back to C$0.9926 versus the US$, or $1.0075, unchanged from Monday's close.
While the bank's growth and inflation outlook was slightly more downbeat, the relatively positive overall tone surprised some investors.
"It was a little odd because data right now is not really supportive of rate hikes ... the U.S. is still muddling along, Europe is in a recession and Chinese growth is a little slower than expected," said Darcy Briggs, a Calgary-based fixed-income fund manager with Bissett Investment Management, a unit of Franklin Templeton.
The currency's gains were limited by a broader rally in the safe-haven U.S. dollar after lackluster corporate earnings and a downgrade of Spanish regions re-ignited fears about the health of the world economy.
Still, the Canadian dollar was stronger against most major currencies, including the euro, British pound , Swiss franc and Australian dollar .
"Given the fact that we've got a pretty sour mood in the global markets today, that's a pretty important move by the Canadian dollar," said Doug Porter, deputy chief economist at BMO Capital Markets.
The Bank of Canada news also hit short-term government bond prices, while longer-term prices were supported by broader caution.
The two-year bond was off 8 Canadian cents to yield 1.136 percent, while the benchmark 10-year bond rose 18 Canadian cents to yield 1.853 percent.
"The long end is still being supported by a bit of weakness in other financial markets today more broadly, but the short end got walloped by this," BMO's Porter said.
Notwithstanding the knee-jerk reaction in the session, Bissett's Briggs said he did not anticipate significant movement in bond yields in the near term as he expects the central bank to continue to hold rates steady.
"The jury's still out, from my vantage point," he said.
Overnight index swaps, which trade based on expectations for the central bank's key policy rate, showed that after the announcement traders resumed placing small bets on the possibility of a rate hike in 2013. (Additional reporting by Andrea Hopkins and Claire Sibonney in Toronto; Editing by Jeffrey Hodgson and Leslie Adler)