* Doubts govt can create debt guarantee fund with reserves
* Local banks hit as they major Argentine bond holders
* Sell off limited on high expectations behind 09 rally
BUENOS AIRES, Jan 8 (Reuters) - Argentina's currency, bonds and stocks weakened on Friday amid political conflict over the president's plan to use the Central Bank's foreign reserves to guarantee debt payments this year.
The benchmark MerVal stocks index .MERV was off 1.24 percent to 2,359.80 points at 1740 GMT, partly recovering from a fall of more than 2 percent in early trade.
The country's biggest financial conglomerate Grupo Financiero Galicia GFG.BA was one of the top value leaders, off 1.37 percent to 2.16 pesos per share.
Local banks are major holders of Argentine sovereign bonds and their stock tends to fall when bond prices are hit.
Bond prices fell an average 1.7 percent in over the counter trade in Buenos Aires, as measured by Reuters, on doubts over whether the government will be able to create its debt guarantee fund with foreign reserves.
The fund would remove perceived risk of a default as debt obligations rise steeply this year just as growth in government income has slowed due to an economic slowdown.
Political tensions rose after President Cristina Fernandez threw out the Central Bank chief through a decree on Thursday.
"The government's decision muddies the political scenario ... people who are taking positions are trying to take advantage of the volatility," said Horacio Corneille, director of Corneille brokerage in Buenos Aires.
The risk spread on Argentine bonds widened by 13 basis points to 682 basis points over comparable U.S. treasuries, according to the benchmark J.P. Morgan Emerging Market Bond Index 11EMJ. Earlier in the day the spread jumped to 701 basis points, a three week high.
The Boden 12 bond denominated in dollars ARBODEN12D=RASL dropped 2.29 percent to an ask price of 32.6.
Last year, Argentina's international debt was red hot, returning a 132.8 percent gain, according to the JP Morgan EMBI Plus.JPMEMBIPLUS.
That made Argentina the best 2009 performer among EMBI components The overall index showed a 25.948 percent return.
Double-digit debt investment yields, roughly $48 billion in reserves and movement toward cleaning up leftover fallout from its huge 2001/02 debt default were factors behind the rally.
"A lot of expectations were behind the rally, and Argentina has not sold off that much when you compare it to other credits," said David Spegel, ING's global head of emerging markets strategy in New York.
The interbank peso weakened by 0.13 percent to 3.7975/3.8000 per U.S. dollar ARS=RASL. (Reporting by Jorge Otaola in Buenos Aires and Daniel Bases in New York; Writing by Fiona Ortiz; Editing by Andrew Hay)