* Canadian dollar backs off seven-month high
* Ottawa forecasts bigger deficit but gives no specifics
* Bonds little changed with few factors influencing market
* Liquidity thin due to holidays in UK, U.S.
By Ka Yan Ng
TORONTO, May 25 (Reuters) - The Canadian dollar eased against the U.S. currency in thin trading on Monday, retreating after a four-day climb to its highest level in seven months, but it shrugged off Finance Minister Jim Flaherty's forecast of a bigger federal deficit this year.
Late in the session, Flaherty said the deficit will be "substantially more" than the C$33.7 billion that he forecast in the government's January budget. [ID:nN25449361]
"We fully expected capitulation of this sort at the federal level," said Eric Lascelles, chief economics and rates strategist at TD Securities.
"At the time they were reasonable (forecasts), but fairly quickly it became clear that the economy was turning down more sharply than those initial estimates," he said.
The Canadian dollar finished at C$1.1235 to the U.S. dollar, or 89.01 U.S. cents, down from C$1.1203 to the U.S. dollar, or 89.26 U.S. cents, at Friday's close.
It reached as high at C$1.1194 to the U.S. dollar overnight, but stayed in a 55-basis point range between C$1.1224-C$1.1279 during North American hours as market liquidity dropped with holiday market closures in the United States and Britain.
"Markets are thin," said David Watt, senior currency strategist at RBC Capital Markets. "Maybe the U.S. Treasury auction this week will be the tipping point for sentiment on the (U.S.) dollar and whether or not it makes a comeback or just gets beaten up again."
Given ongoing concerns about ballooning U.S. debt levels, markets await the U.S. Treasury's two-, five- and seven-year debt auctions this week, which will total $101 billion -- an important test of investor appetite for dollars and dollar assets.
Part of the Canadian currency's 5-percent surge last week was connected to market worries about the solidness of the AAA credit ratings of the United States, which knocked the U.S. currency lower.
Market players will have to wait until the end of the week for any Canadian economic data, with the current account balance for the first quarter on tap.
First-quarter GDP figures next Monday will likely be more critical in helping the market gauge the pace of the economy's recovery, just ahead of the Bank of Canada's next interest rate announcement on June 4.
However, U.S. data this week may prove to be the driver with a raft of housing data due, including new and existing home sales statistics, with the focus on whether the U.S. housing market is stabilizing.
BONDS UNCHANGED TO LOWER
Canadian bonds were mixed, without strong impetus to push in either direction with U.S. Treasuries not trading because of the Memorial Day holiday.
Flaherty's deficit comments made few waves in the bond market, where prices were little changed throughout the session.
Canadian bonds may be more active later this week with the upcoming Treasury auction and U.S. housing data.
The benchmark two-year government bond was unchanged at C$100.19 to yield 1.154 percent, while the 10-year bond slipped 15 Canadian cents to C$103.95 to yield 3.284 percent.
The 30-year bond was off 5 Canadian cents at C$117.20 to yield 3.977 percent. (Editing by Peter Galloway)