* C$ softer at 94.57 U.S. cents
* Bond prices gain across curve (Updates with Bank of Canada rate decision)
By Claire Sibonney
TORONTO, July 20 (Reuters) - The Canadian dollar fell slightly against its U.S. counterpart on Tuesday morning after the Bank of Canada raised its key interest rate but warned that economic recovery at home and abroad will be slower than thought, foreshadowing a more hesitant pace of rate hikes from now on.
Last month, the bank became the first in the G7 advanced economies to raise rates from the emergency lows introduced during the global economic crisis. It took a second step on Tuesday by lifting borrowing costs by another 25 basis points to 0.75 percent, a move unanimously predicted by Canada's primary securities dealers. [ID:nN20251478]
But the bank also cut its growth forecast for Canada for this year and said Europe's efforts to reduce sovereign debt would temper the global recovery as well.
"It looks like all that fiscal retrenchment coming down the pipeline in Europe and eventually in the United States will dampen the economic outlook externally and that, of course, has implications for Canada," said Sal Guatieri, senior economist at BMO Capital Markets.
"I would not expect pronounced weakness (in the Canadian dollar), but it is certainly in line with the view that the Bank of Canada might not raise interest rates at every subsequent meeting over the next year."
Higher rates typically help a currency by attracting capital flows, but investors said that effect has been priced in.
The Canadian dollar was already skewed to the downside ahead of the rate decision as risk aversion seeped back into global markets following a string of disappointing U.S. earnings news.
At 9:37 a.m. (1337 GMT), the Canadian dollar CAD=D4 was at C$1.0574 to the U.S. dollar, or 94.57 U.S. cents, down slightly than Monday's finish of C$1.0549 to the U.S. dollar, or 94.80 U.S. cents.
Earlier in the session, the Canadian dollar CAD=D4 touched a low of C$1.0587 against the greenback, or 94.46 cents, its weakest level since July 7, but market watchers said the impact on the currency should be limited.
Short-term money market rates rose after the tightening, but bond yields mostly fell. The yield on the two-year Canadian government bond CA2YT=RR fell to 1.48 percent from 1.514 percent just before the news.
"I think the markets were widely expecting a dovish commentary. It may result in some modest further rallying in the bond market," said Sheryl King, chief Canadian economist at Banc of America-Merrill Lynch.
The 10-year bond CA10YT=RR extended gains, with the yield falling to 3.111 percent from 3.158 just before the rate announcement. (Additional reporting by John McCrank and Euan Rocha; editing by Peter Galloway)