* Oil price, gloomy U.S. data support Canadian dollar
* Bonds fall sharply as safe-haven appeal lessens
* Normal volumes seen next week
TORONTO, Jan 2 (Reuters) - The Canadian dollar edged higher against the U.S. currency on Friday, supported by a turnaround in the price of crude oil and a gloomy U.S. reading of the manufacturing sector.
Bonds turned lower as the Toronto Stock Exchange marched toward a fourth straight session of triple-digit gains.
The Canadian dollar finished at C$1.2156 to the U.S. dollar, or 82.26 U.S. cents, up from Wednesday's close at C$1.2180 to the U.S. dollar, or 82.10 U.S. cents. Canadian markets were closed on Thursday for New Year's Day.
A U.S. index of manufacturing activity fell more than expected to a 28-year low, but its boost to government debt was short-lived and it also had a fleeting impact on the currency. See [ID:nWEN2173]
Oil staged a late morning rally and never looked back, rising 4 percent to settle above $46 a barrel.
"It's a pretty cut-and-dried economic and commodity story that is pushing the currency upwards," said Eric Lascelles, chief economics and rates strategist at TD Securities.
Still, the currency has been fairly rangebound for the past three weeks, he said. With the exception of a couple of mid-December sessions where it popped into C$1.19 territory, the Canadian dollar has largely stuck within a range of C$1.21-C$1.23 to the U.S. dollar.
Paul Ferley, assistant chief economist at Royal Bank of Canada, said next Friday's employment reports for December in both Canada and the United States will be closely watched after "fairly pronounced" drops in November. But thin markets were likely exaggerating moves.
"We'll probably get a firmer indication of the underlying trend in the currency when trading starts next week," Ferley said.
The Canadian dollar slumped nearly 19 percent in 2008, its worst annual drop versus the U.S. currency in more than half a century, as plunging commodity prices in the second half of the year took their toll.
But the decline came on the heels of an unusually strong 2007 performance against the greenback and the Canadian dollar did rise against other currencies such as its commodity cousins, the New Zealand and Australian dollars.
BONDS DROP
Government bond prices reversed early strength as rising North American stock markets gathered momentum and despite dismal U.S. factory data.
U.S. and Canadian stocks indexes extended recent rallies to start the new year, dampening the appeal of safe-haven government debt. The TSX composite and the Dow Jones average both gained more than 200 points.
A U.S. index of manufacturing activity fell more than expected to a 28-year low, but its boost to government debt was short-lived. See [ID:nWEN2173]
"I'm still a little surprised by the magnitude of the selloff," said TD's Lascelles. "One theme could be that there was a quest for liquidity and safety going into the end of the calendar year. Of course that now unwinds so there's scope for selling government bonds and buying products of other sorts, including stocks."
The two-year Canada bond fell 13 Canadian cents to C$102.97 to yield 1.166 percent, while the 10-year bond slid C$1.35 to C$111.55 to yield 2.841 percent.
The yield spread between the two-year and 10-year bond was 167.5 basis points, versus 159 at the previous close.
The 30-year bond declined C$2 to C$125.70 to yield 3.555 percent. In the United States, the 30-year treasury yielded 2.823 percent. (Reporting by Ka Yan Ng; editing by Rob Wilson)
