* C$ sinks to C$1.0371 vs US$, or 96.42 U.S. cents
* Europe worries persist despite German vote
* Bonds prices mostly lower (Adds analyst comment, updates levels)
By Andrea Hopkins
TORONTO, Sept 29 (Reuters) - The Canadian dollar weakened in afternoon trade against its U.S. counterpart on Thursday as a relief rally over progress on the European debt crisis proved short lived, and investors returned to the safety of the U.S. dollar.
The Canadian currency had initially firmed after Europe again averted disaster in its debt crisis when German lawmakers rallied behind Chancellor Angela Merkel to approve a stronger euro zone bailout fund, known as the European Financial Stability Facility (ESFS).
"It was nice to get the German passage of the ESFS bill but that's hardly the signal that the EU crisis is over. If anything it is just the start of the next phase of the crisis. So that euphoria faded rather quickly as reality began to sink in," said David Watt, senior currency strategist at Royal Bank of Canada.
Bigger challenges loom for the euro zone now. Financial markets are already anticipating a likely Greek default and demanding more far-reaching measures to prevent the crisis that began in Athens from spreading far beyond Europe and its banks.[ID:nL5E7KT2WC].
The Canadian dollar, which had also been buoyed early in the day by stronger-than-expected U.S. economic news, reversed course and weakened to fresh session lows.
At 1:32 p.m. (1730 GMT), the Canadian dollar CAD=D3 stood at a session-low C$1.0371 to the U.S. dollar, or 96.42 U.S. cents, below Wednesday's North American session close of C$1.0326, or 96.84 U.S. cents.
It had rallied as high as C$1.0256 to the U.S. dollar, or 97.50 U.S. cents, after the U.S. data was released.
TD Securities said the day's range for the currency should hold between C$1.0150-C$1.04.
Initial claims for U.S. unemployment benefits last week fell to a five-month-low of 391,000, well below economists' expectations for 420,000 and below the key 400,000 level for the first time since early August.
Separately, the U.S. economy grew at annual rate of 1.3 percent, the government said in its final estimate for the second quarter, up from the previously estimated 1.0 percent.
That reflected consumer spending and export growth that was stronger than earlier estimated. [ID:nS1E78S0BT]
Worries about the European debt crisis remained a pressing factor in currency markets, and sentiment has whipsawed between fear and hope for the past week.
"Essentially the market is just trying cling to risk-on but having trouble," said Camilla Sutton, chief currency strategist at Scotia Capital.
"As every vote for the EFSF 2 gets passed, that's one more hurdle cleared but I think generally the market recognizes that it's not just the passing of the EFSF 2 that's the solution. We probably need a bigger, broader solution than that."
Bond prices were mostly lower. The two-year Canadian government bond CA2YT=RR was down 1 Canadian cent to yield 0.933 percent, while the 10-year bond CA10YT=RR lost 38 Canadian cents to yield 2.237 percent. (Additional reporting by Claire Sibonney; Editing by Jeffrey Hodgson)