CANADA FX DEBT-Loonie weakens on wider trade deficit, U.S. impasse

* C$ at C$1.0368 vs US$, or 96.45 U.S. cents
    * Shutdown, looming debt ceiling deadline create risk
    * Canada's trade deficit rises to C$1.31 billion
    * Bond prices mixed

    By Leah Schnurr and Alastair Sharp
    TORONTO, Oct 8 (Reuters) - The Canadian dollar weakened
against the greenback on Tuesday after the trade deficit widened
more than expected in August and as the government shutdown
south of the border dragged on.
    U.S. President Barack Obama said he would be willing to
negotiate with Republicans over budget issues only after they
agree to re-open the federal government and raise the debt limit
with no conditions. 
    While investors have largely taken the 8-day-old shutdown in
stride, the threat that the world's largest economy does not
raise its debt threshold and technically defaults later this
month has sparked fears of potential global economic havoc.
    "The U.S. government shutdown has now been tied together
with the debt ceiling, because the deadline is looming late next
week," said Greg Moore, currency strategist at TD Securities.
    "If the U.S. does in fact default, your guess is as good as
mine on what happens and the U.S. dollar may in fact sell off
quite sharply initially," Moore said.
    While the U.S. currency was flat near eight-month lows
against major currencies on Tuesday, it outperformed so-called
risk currencies such as the Canadian dollar.
    Canada's trade deficit rose to C$1.31 billion ($1.27
billion) as imports grew to set a record. The data offset a more
upbeat report that showed housing starts jumped in September.
    "Exports are a large part of the Canadian economy and they
are really going to underpin the recovery for us," said Scott
Smith, senior market analyst at Cambridge Mercantile Group in
Calgary. "So, if they are not progressing as fast or as well as
we'd like, then we're going to see some loonie selling on the
prospects moving forward for the whole economy."
    Because of the role it plays in the economy, the export
sector is also a significant focal point for the Bank of Canada
in terms of when the central bank will raise interest rates,
said Smith.
    The Bank of Canada earlier in the month cut its
third-quarter economic growth forecast and said the export
sector might recover more slowly than expected.
    The Canadian dollar ended the day at C$1.0368, or
96.45 U.S. cents, weaker than Monday's close of C$1.0313, or
96.96 U.S. cents. The Canadian currency briefly hit a session
high of C$1.0308 shortly after the housing data.
    The United States has until mid-October before it hits the
$16.7 trillion borrowing limit. The impasse was reminiscent of
the 2011 showdown over the debt ceiling, which yielded an
agreement only at the last minute.
    "With markets looking back at 2011 and saying an
eleventh-hour deal was done then, expectations are we'll get
something hammered out before Oct. 17," said Smith.
    Following a brief spike after the Federal Reserve's decision
to stand pat on its economic stimulus on Sept. 18, the Canadian
dollar has been trading in a tight range for several sessions.
    The minutes of that Fed meeting will be released on
Wednesday, perhaps offering clues as to how close the bank came
to a scaling back of stimulus.
    "It will be quite interesting to see the tone of that
discussion," TD's Moore said.
    Analysts see the loonie in a range between mid-C$1.02 and
mid-C$1.03 for now, baring a resolution or other catalyst.
    Prices for Canadian government bonds were mixed across the
maturity curve. The two-year bond slipped half a
Canadian cent to yield 1.190 percent, while the benchmark
10-year bond gained 3 Canadian cents to yield 2.566