* Canadian dollar rises 0.4 percent on M&A interest
* Bank of Canada expected to leave rates steady on Tuesday
* Bond prices rally on U.S. financial worries
By John McCrank
TORONTO, July 14 (Reuters) - The Canadian dollar rose 0.4 percent against a resurgent U.S. dollar on Monday, mainly due to merger-related interest in Canada's energy sector.
Canadian bond prices, with no domestic data to consider, rallied along with the U.S. Treasury market due to jitters about the state of the U.S. financial system.
The Canadian currency closed at C$1.0052 to the U.S. dollar, or 99.48 U.S. cents, up from C$1.0094 to the U.S. dollar, or 99.07 U.S. cents, at Friday's close.
The currency rose early in the session after Royal Dutch Shell RDSa.L said it would buy Alberta-based Duvernay Oil Corp DDV.TO for around C$5.9 billion. See [ID:nL14689410].
"Even though we had the U.S. dollar bouncing back from its lows earlier in the day, it didn't really have much traction against the Canadian dollar," said David Watt, senior currency strategist at RBC Capital Markets.
Looking forward, the main events of the week will be the Bank of Canada's interest rate announcement on Tuesday and its updated monetary policy report on Thursday.
A Reuters poll taken Friday showed Canada's primary securities dealers expect the central bank to leave its key lending rate steady at 3.00 percent on Tuesday. That means the majority of attention will be on its accompanying statement, from which market players will try to glean some insight into its future moves.
"The wild card is whether they will make any statements about terms of trade, or those kinds of issues, which would be CAD positive," Watt said.
At its last monetary policy announcement, the central bank highlighted risks from inflation, which could indicate an interest rate hike is in the cards somewhere down the road. But with the Canadian economy hamstrung by the U.S. slowdown, the central bank doesn't have much room to maneuver, and a stronger Canadian dollar would help dampen inflation, Watt said.
Bank of Canada Governor Mark Carney presented a speech in Calgary a couple weeks ago and talked about oil prices being driven by fundamentals, with speculation having very little role. Canada is a major exporter of oil and its currency often tracks movements in the price of the commodity, although less so lately. So the Canadian dollar may have room to rise.
"I think there are very good reasons to suspect the Bank of Canada will leave the lasting impression that they wouldn't be upset with a little bit more CAD strength to help take the pressure off them having to decide to possibly hike interest rates," Watt said.
Canadian bond prices rallied along with U.S. Treasury prices as concerns in the U.S. banking sector took some of the steam out of stock markets, while upping the bid for safe-haven government debt.
"Lost in last Friday's Fannie Mae FNM.N and Freddie Mac FRE.N kerfuffle was that IndyMac Bank went under and there's been all sorts of focus on U.S. regionals today," said Sheldon Dong, fixed income strategist at TD Waterhouse Private Investment.
On Friday, IndyMac suffered a run on its deposits, resulting in the third-largest bank failure in U.S. history.
The two-year bond rose 11 Canadian cents to C$101.14 to yield 3.118 percent. The 10-year bond climbed 62 Canadian cents to C$104.45 to yield 3.707 percent.
The yield spread between the two-year and 10-year bond was 58.9 basis points, down from 59.4 basis points, unchanged from the previous close.
The 30-year gained 70 Canadian cents to C$116.05 for a yield of 4.051 percent. In the United States, the 30-year treasury yielded 4.446 percent.
The three-month when-issued T-bill yielded 2.31 percent, down from 2.34 percent at the previous close. (Editing by Peter Galloway)