ANALYSIS-Russia move C$ positive, but limits seen to gains

* Russia says to buy Canadian dollars

* C$ rallies to one-week high

* C$ liquidity could be issue for other big US$ holders

* Bank of Canada policy seen capping gains

By Frank Pingue

TORONTO, Nov 25 (Reuters) - Russia gave Canada's dollar new luster on Wednesday with a plan to add the currency to its foreign exchange reserves, a move that could spur similar buying by other major U.S. dollar holders.

But analysts warned that demand for Canadian dollars by central banks and similar players will be limited by the currency's lower liquidity, and that other factors could keep it from strengthening on the increased interest.

"It's natural to suspect that given the characteristics of the currency, the sovereign rating and general characteristics of the domestic policy environment, it makes sense that reserve managers would be interested," said Dan Katzive, FX strategist at Credit Suisse in New York.

"But the size of the market is too small to allow for more than a token representation of global reserves."

Russia's central bank said on Wednesday it was preparing to invest some foreign exchange reserves in Canadian dollars to diversify its portfolio and lessen reliance on the U.S. dollar in international trade. [ID:nGEE5AO19O]

The decision was not entirely a surprise, as a central bank official said in September that Canadian and Australian dollars could be added to reserves. [ID:nLT556258].

But the news came on a day when the greenback was already falling and intensified the move. It helped send the Canadian dollar to C$1.0450 to the U.S. dollar, or 95.69 U.S. cents, its highest level since Nov. 18. [CAD/]

The Canadian dollar has already rallied about 25 percent from the four-year low it skidded to in March as appetite for risk among investors has grown.

The Russian move comes as officials in other countries, including China, voiced concern about the prospect for extended greenback weakness. Most central banks hold large amounts in U.S. dollars because of the greenback's role as the global reserve currency.

There is speculation these central banks, along with other big dollar holders like sovereign wealth funds, could diversify by selling dollars to buy currencies such as euros, sterling, yen, or commodity-linked plays like Canada.

EURO, YEN FAVORED

Some experts noted that because of trade patterns, other central banks may favor bigger, more liquid alternatives to the U.S. dollar, making Russia's move something of a "one-off".

"It would be surprising to see a sustained accumulation of Canadian dollars in FX reserves of other countries," said Michael Woolfolk, senior currency strategist at BNY Mellon in New York.

"As they continue to diversify away from (U.S.) dollars, the natural beneficiary of this will be the euro and to a lesser degree the yen."

Analysts warn investors hoping for strong Canadian dollar gains on the back of central bank buying are likely to be frustrated by the Bank of Canada.

Credit Suisse's Katzive said that if reserve diversification flows send the Canadian dollar higher, the country's central bank will be more reluctant to tighten monetary policy.

Canadian interest rates are already at a record low and the Bank of Canada has conditionally pledged to keep them there until at least the middle of next year.

Katzive said a delay in tightening would make Canada's currency an attractive funding vehicle. Investors could borrow cheaply in Canadian dollars and sell them to buy assets denominated in more growth-sensitive currencies such as Australia's.

Still, analysts said the long-term outlook for the Canadian dollar is strong because of its positive fundamentals.

These include exposure to price gains for commodities exported to high-growth markets such as China and India, low debt- and deficit-to-GDP ratios relative to the currency's Western peers, and an 'AAA' rating that does not look vulnerable to a near-term downgrade.

Russia's decision "is just another indicator that the U.S. dollar has lost its luster at the moment," said Steve Butler, director of foreign exchange trading at Scotia Capital.

"The market is going to continue to look for other places to park reserves and certainly Canada is in a much more favorable light right now than the U.S." (Editing by Jeffrey Hodgson) ((frank.pingue@thomsonreuters.com ; +1 416 941-8094; Reuters Messaging: frank.pingue.reuters.com@reuters.net))