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CANADA FX DEBT-C$ strengthens as factory sales climb, yield gap shrinks

* Canadian dollar at C$1.2585, or 79.46 U.S. cents

* Bond prices lower across the yield curve

* Canada-U.S. 2-year spread hits narrowest since Aug. 18

TORONTO, July 19 (Reuters) - The Canadian dollar edged higher on Wednesday against the greenback as the U.S. yield advantage shrunk and oil prices rose, while domestic data showed a larger-than-expected increase in manufacturing sales. Canadian factory sales grew by 1.1 percent in May from April, hitting a record level on higher sales of motor vehicles and parts, data from Statistics Canada showed. Analysts had forecast an increase of 0.8 percent. The data shows that "the goods sector is delivering the goods for the Canadian economy," Avery Shenfeld, chief economist at CIBC Capital Markets, said in a research note. The gap between Canada's 2-year yield and its U.S. equivalent narrowed by 1.8 basis points to a spread of -14.1 basis points, its narrowest since Aug. 18. The narrower spread came after the Bank of Canada raised interest rates last week for the first time since 2010 and signaled it would hike again over the coming months. Prices of oil, one of Canada's major exports, were supported producers revived concerns about a persistent overhang of excess crude.

U.S. crude prices were up 0.13 percent at $46.46 a

barrel.

At 9:26 a.m. ET (1326 GMT), the Canadian dollar was

trading at C$1.2585 to the greenback, or 79.46 U.S. cents, up 0.3 percent. The currency traded in a range of C$1.2585 to C$1.2653. On Tuesday, it had touched its strongest since early May 2016 at C$1.2581. The loonie has gained roughly 7 percent since the Bank of Canada turned hawkish in June. Canadian and Mexican officials will meet on Wednesday to discuss how to handle negotiations on NAFTA, two sources said on Tuesday, as a Canadian diplomat hinted at a potential clash with Washington. Canadian government bond prices were lower across the yield

curve, with the two-year down 3 Canadian cents to yield 1.211 percent and the 10-year falling 20

Canadian cents to yield 1.882 percent. Retail sales data for May and the June inflation report are due out on Friday.

(Reporting by Fergal Smith; Editing by Meredith Mazzilli)