* Higher oil prices key driver behind C$’s gain
* Muted reaction to priced-in Canada political news
* C$ backs off 2-week high after Fed statement
* Bond prices drop as stocks gain, supply concerns (Recasts with closing numbers)
By Frank Pingue
TORONTO, Jan 28 (Reuters) - Canada’s dollar closed higher on Wednesday as oil prices rose and the country’s Conservative government avoided defeat, but the currency fell from session highs after a market-moving U.S. Federal Reserve statement.
Late in the session the Canadian currency looked primed for a hefty gain of about 1.5 percent, but did an about face after the Fed said it was prepared to keep using unconventional tools to help the U.S. economy from deteriorating further.
“The (U.S.) dollar basically just turned on its tail and obviously the FOMC meeting sparked that,” said David Watt, senior currency strategist at RBC Capital Markets.
“You basically had the Fed indicating that they will do everything they can to keep rates at zero for a long time ... and do everything they can to spark an economic rebound.”
The Fed pacified markets as it suggested it would pull out all the stops to lift the economy out of recession and may even buy long-term government debt.
The Canadian dollar closed at C$1.2152 to the U.S. dollar, or 82.29 U.S. cents, up 0.9 percent from its Tuesday close of C$1.2263 to the U.S. dollar, or 81.55 U.S. cents.
Domestic bond prices ended lower as investors flocked to riskier assets like equities while supply concerns continued to weigh on more secure government debt.
The Canadian dollar moved higher in the overnight session, boosted by higher prices for some key exports like oil.
It steered clear of sharp swings during the first half of the session as traders awaited the Liberal Party’s verdict on Tuesday’s budget, which included a two-year C$40 billion economic stimulus package.
In the end, the country’s opposition Liberals made a widely expected decision to support the budget, preventing the fall of the ruling Conservatives. The Canadian dollar showed little reaction to the news, sticking near higher levels.
“The shock would’ve been if the Liberals had done something to indicate that they were going to cut short the session of parliament or vote against the budget,” said RBC’s Watt.
“In the backdrop we have the rebound in confidence globally ... people aren’t looking for a reason to sell risk.”
Canadian bond prices ended lower across the curve as the lack of any domestic data to influence direction left its move dictated by the bigger U.S. Treasury market, where debt prices dropped on concerns about supply.
A rally in equity markets also did little to help the bond market. Toronto's S&P/TSX composite index .GSPTSE rose 1.67 percent, while the Dow Jones industrial average had a gain of 2.46 percent.
“The market is digesting the looming onslaught of new government issues over the next one to two years to finance the budget spending,” said Sal Guatieri, senior economist at BMO Capital Markets. “That higher supply just means downward pressure on the bond market.”
In one positive development for the Canadian bond market, ratings agency Moody’s said on Wednesday that plans to run budget deficits after more than a decade in surplus are unlikely hurt its Aaa government bond rating given the country’s strong fundamentals, [ID:N28533673]
The two-year bond dropped 10 Canadian cents to C$102.49 to yield 1.372 percent, while the 10-year bond fell 55 Canadian cents to C$110.42 to yield 2.963 percent.
The 30-year bond fell 85 Canadian cents to C$122.35 to yield 3.717 percent. In the United States, the 30-year Treasury yielded 3.419 percent.