CANADA FX DEBT-C$ weakens on U.S. debt fears, eye on U.S. vote

* C$ falls to C$0.9516 vs US$, or $1.0509

* U.S. uncertainty keeps money on sidelines, vote looms

* Bond prices mostly firmer

TORONTO, July 28 (Reuters) - The Canadian dollar edged lower against its U.S. counterpart on Thursday, trading in a tight range as investors awaited a crucial vote in the United States on a bill to cut the deficit.

The Canadian currency had strengthened earlier in the day but sold off slightly as a vote loomed in the United States on Thursday, where lawmakers are working to compromise on a deficit reduction plan that would head off a U.S. default.

“It’s been in a very tight range in the last couple of days, and we’re just kind of waiting for some outcome in the U.S., some announcement on the U.S. debt crisis,” said David Bradley, director of foreign exchange trading at Scotia Capital.

He said the Canadian dollar remained a preferred currency for central banks looking to diversify out of the U.S. dollar and euro currencies, given the debt crises facing each region. Like other commodity-linked currencies, the Canadian dollar has benefited from a flight-to-safety flow in recent months.

Moody’s debt rating agency reaffirmed its Aaa rating on Canada’s sovereign debt in its annual report on Canada on Thursday, citing the nation’s economic resiliency, very high government financial strength and a low susceptibility to event risk.

“Canada has weakened today but it looks like it will outperform further down the road in this environment, with commodities fairly stable,” Bradley said.

The Canadian dollar firmed early in the session following news that U.S. claims for unemployment benefits dropped below the key 400,000 level for the first time since early April, pointing to some improvement in the U.S. labor market.

But it softened as North American stocks weakened and bonds gained on mounting concerns about a U.S. debt default and separate debt concerns in Europe. [MKTS/GLOB]

The stalemate in Washington over lifting the debt ceiling by an August 2 deadline is increasing the possibility of a U.S. credit rating downgrade and has raised the prospect that the government of the world’s leading economy will run out of money to pay its bills. [nN1E76R004]

While the Canadian dollar has struggled to regain 3-1/2 year highs reached early in the weak as investors focus on its close ties to the struggling U.S. economy, Bradley said weakness has generally been countered by central bank appetite to diversify.

“Any time the Canada dollar weakens off it always seems to be met by strong interest to buy it from these central bank types,” Bradley said. “The central banks have made the market aware they are diversifying out of dollar and euro and into the Canada dollar, into the Aussie.”

The Canadian dollar CAD=D4 closed at C$0.9516 to the U.S. dollar, or $1.0509, down from Wednesday's North American session close at C$0.9489 to the U.S. dollar, or $1.0539.

Looking ahead, markets will be eyeing GDP figures on both sides of the border on Friday.

Canadian bond prices were mixed, though the uneven tone in stock markets throughout the session provided some support.

The two-year Canadian government bond CA2YT=RR was down 1.5 Canadian cents to yield 1.48 percent. The 10-year bond CA10YT=RR rose 2 Canadian cents to yield 2.876 percent. (Editing by Jeffrey Hodgson)