* Oil prices drop to 13-month low
* Plunge on stock markets adds to pressure on currency
* Bond prices rally as stocks fall, data disappoints
By Frank Pingue
TORONTO, Oct 15 (Reuters) - The Canadian dollar fell sharply versus the U.S. dollar on Wednesday as a slide in the price of oil, a key Canadian export, dragged the currency down by 2 percent and stripped it of the gains recorded early this week.
Canadian bond prices closed higher across the curve due to some weak U.S. economic data, an equity market selloff and market expectations for more central bank rate cuts.
The Canadian dollar closed at C$1.1879 to the U.S. dollar, or 84.18 U.S. cents, down from C$1.1616 to the U.S. dollar, or 86.09 U.S. cents, at Tuesday's close.
Part of the Canadian dollar's decline was pegged on a slide in oil prices to a 13-month low due to fears that economic weakness will cut further into demand for crude.
Since Canada is the main supplier of oil to the United States, and commodities make up about half of Canadian exports, the currency often follows the direction of oil prices.
Another factor dragging the Canadian currency lower was the slide in equity markets, which creates an environment for the greenback to rally as investors become wary of risk.
"More weakness in crude ... and the focus there still seems to be on lessening global demand," said Shane Enright, currency strategist at CIBC World Markets. "And as you see continued asset market weakness ... the prime beneficiary of all of these things has been the U.S. dollar.
During the overnight session, the Canadian dollar rallied to C$1.1540 to the U.S. dollar, or 86.66 U.S. cents, but it spent the entire North American session relinquishing those gains and returning to last week's levels.
News late on Tuesday that Canada had reelected a minority Conservative government had little impact on the currency.
A report on Wednesday from the Conference Board of Canada said the Canadian economy will avoid slipping into a recession as domestic demand helps offset the negative impact of falling commodity prices.
BOND PRICES RALLY
Canadian bond prices all ended higher as Tuesday's big rally by Toronto's main stock index was followed by a wave of selling on Wednesday while economic data continued to paint a bleak picture for the global economy
"Economic data is pointing towards a global recession," said Sheldon Dong, fixed income analyst at TD Waterhouse Private Investment. "And equity markets ran out of steam and that surprised a lot of people ... so that would also explain the demand for bonds."
The Toronto Stock Exchange's main index fell 6.6 percent, while the Dow Jones industrial average dropped 7 percent.
The latest batch of economic data showed a steep slide in U.S. September retail sales, while a gauge of manufacturing in New York state fell to its lowest level since its inception in 2001. Also, European data has continued to disappoint.
With markets still focused on the global financial crisis and data showing that no end is in sight, expectations for more central bank interest rate cuts remain on the table.
The two-year bond rose 15 Canadian cents to C$100.99 to yield 2.269 percent. The 10-year bond was up 43 Canadian cents at C$103.85 to yield 3.768 percent.
The yield spread between the two-year and the 10-year bond moved to 123 basis points from 116 basis points at the previous close.
The 30-year bond rallied C$1.27 to C$113.15 to yield 4.205 percent. In the United States, the 30-year Treasury yielded 4.226 percent. (Editing by Peter Galloway)