CANADA FX DEBT-C$ firms near 3-1/2 yr high as debt fears hit US$

* C$ ends session at C$0.9458 to US$, or $1.0573

* Near 3-1/2 year high as U.S. debt woes persist

* Canada currency taking on safe-haven character

* Bond prices softer, but outperform Treasuries (Updates to close, adds analyst comments, details)

By Andrea Hopkins

TORONTO, July 25 (Reuters) - The Canadian dollar finished stronger against its U.S. counterpart on Monday, within sight of last week’s 3-1/2 year high, as a stalemate in U.S. debt talks boosted Canada’s flight-to-safety status.

The breakdown in U.S. budget talks has fueled demand for perceived safe-haven currencies, as the greenback hit a record low versus the Swiss franc and a four-month trough against the yen. [FRX/]

“In the absence of any debt deal in the U.S., markets are still very nervous and with that nervousness Canada is continuing to be one of the favorites,” said Steve Butler, director of foreign exchange trading at Scotia Capital.

“We do get a bit of short-covering toward the end of the day as people get a little bit leery going home too long Canada at 3-1/2 year highs, but I think we’ll be trading down towards the mid 93s later in the week all things being equal.”

The currency CAD=D4 finished the session at C$0.9458 to the U.S. dollar, or $1.0573, up from Friday's North American session close of C$0.9491 to the U.S. dollar, or $1.0536.

The currency hit a session high of C$0.9434, near the 3-1/2 year high of C$0.9424 it reached on Thursday. The Canadian dollar rallied last week on market perceptions of a more hawkish tone from the Bank of Canada.

Most investors expect a U.S. deal will be done before the Aug. 2 deadline to avert default. But the lack of progress over how to cut the budget deficit and raise the debt ceiling heightened the possibility of a ratings downgrade of U.S. debt and weighed on risk sentiment, which analysts said would keep dogging the greenback. [nN1E76M0B0][ID:nN1E76N0CA]

David Rosenberg, chief economist and strategist at Gluskin Sheff, said Canada is emerging as a safe haven almost in a league with gold or the Swiss franc, valued for its political stability and solid central bank in addition to its resource base.

“The Canadian dollar’s character may be undergoing a profound transformation. Not just a commodities currency, as much as that in and of itself is an alluring feature, but also a reflection of relative political, fiscal, financial and economic stability in a world that is wracked with uncertainty and instability,” Rosenberg said.

Canadian government bond prices drifted lower, tracking the move in U.S. Treasuries. [US/]

They outperformed their U.S. counterparts across the curve, however, on investor concern that the world’s biggest economy could lose its prized top-notch credit rating.

The two-year bond CA2YT=RR was down 1 Canadian cent to yield 1.507 percent, while the 10-year bond CA10YT=RR lost 1 Canadian cent to yield 2.933 percent.

The Canadian 10-year yield was 7.7 basis points below its U.S. counterpart, compared with 4.5 basis points below on Friday. (Editing by Jeffrey Hodgson)