By Fergal Smith

TORONTO (Reuters) - The Canadian dollar edged higher against its U.S. counterpart on Wednesday as a rally in equity markets offset underwhelming domestic retail sales data, with the currency recovering after it hit its weakest level in nearly three months.

The loonie was trading 0.1% higher at 1.3540 to the greenback, or 73.86 U.S. cents, after earlier touching its weakest intraday level since May 31 at 1.3603.

"We are seeing the Canadian dollar slightly strengthen on the back of a rebound in oil and the rebound in market sentiment and equities as well," said Darren Richardson, chief operating officer at Richardson International Currency Exchange Inc.

"There is a little bit of profit-taking going on as well as people square up after recent losses in the Canadian dollar."

Wall Street's main indexes rose and the price of oil, one of Canada's major exports, clawed back some of its earlier decline. U.S. crude oil futures settled 0.9% lower at $78.99 a barrel.

A pullback in the U.S. dollar also helped the loonie. The greenback fell against a basket of currencies and bond yields fell after data showed U.S. business activity approaching stagnation.

Canadian retail sales grew by 0.1% in June from the previous month driven mostly by car sales, a sign of weak consumer spending that could convince the Bank of Canada that interest rate hikes are sinking in.

Money markets see a 19% chance of a rate hike by the Canadian central bank at its next policy decision on Sept. 6, down from 27% before the data.

Canadian government bond yields were sharply lower across the curve, tracking moves in U.S. Treasuries. The 10-year fell 16.9 basis points to 3.646%.

(Reporting by Fergal Smith; editing by Diane Craft)