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CANADA FX DEBT-Loonie rallies as muted U.S. wage inflation spurs risk appetite

Fergal Smith

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* Canadian dollar rises 0.4% against the greenback

* Loonie touches its weakest intraday since April 26 at 1.3492

* Price of U.S. oil increases 0.2%

* Canada-U.S. 2-year spread hits narrowest in nearly three months

TORONTO, May 3 (Reuters) - The Canadian dollar strengthened against its U.S. counterpart on Friday, recovering from an earlier one-week low as the U.S. jobs report pointed to solid economic growth but tame inflation that could keep the Federal Reserve from raising interest rates. U.S. Treasury yields fell and stocks on Wall Street rose after the jobs data as investors focused on wage inflation that was muted even as nonfarm payrolls increased by 263,000 jobs last month. "What traders are keying off today is this pretty healthy risk-on result after that rather perfect jobs report," said Michael Goshko, corporate risk manager at Western Union Business Solutions. "As long as average hourly earnings don't spike and perhaps give the Fed concern that it might bleed into overall inflation they can be accommodative on interest rates," Goshko said. Canada sends about 75 percent of its exports to the United States, including many commodities such as crude oil. Still, the usual tight link between the loonie and U.S. stocks has waned since March as investors pay more attention to domestic economic headwinds than signs of improved prospects for the U.S. economy.

At 4:00 p.m. (2000 GMT), the Canadian dollar was

trading 0.4% higher at 1.3425 to the greenback, or 74.49 U.S. cents. The currency's strongest level of the session was 1.3406, while it touched its weakest since April 26 at 1.3492. For the week, the loonie was up 0.2% despite domestic data showing a decline in February GDP and that factory activity contracted for the first time in more than three years in April.

Data from the U.S. Commodity Futures Trading Commission and Reuters calculations showed that speculators cut their bearish bets on the Canadian dollar for the second straight week. As of April 30, net short positions had fallen to 46,745 contracts from 47,493 in the prior week.

U.S. crude oil futures settled 0.2% higher at $61.94

a barrel. The Canadian dollar is set to strengthen over the coming year, helped by higher oil prices, but the currency's gains will be held back by the greater interest rate offered to holders of U.S. dollars, a Reuters poll showed. Canadian government bond prices edged lower across the yield curve, while the gap between Canada's 2-year yield and its U.S. equivalent narrowed by 2.7 basis points to a spread of 69.8 basis points in favor of the U.S. bond, its narrowest gap since Feb. 8.

(Reporting by Fergal Smith; editing by Jonathan Oatis and Sandra Maler)