(Adds dropped word "falling" in sixth paragraph quote.)
By Randall Palmer
OTTAWA Aug 22 Canada's annual inflation rate softened more than expected in July and the core rate unexpectedly fell, Statistics Canada said on Friday, but the surprise decline is not likely to worry the central bank.
The July figure comes after annual inflation rose to a 28-month high in June. Bank of Canada Governor Stephen Poloz shrugged off that surge as temporary.
The annual inflation rate fell to 2.1 percent in July from 2.4 percent in June, a touch above the Bank of Canada's 2 percent target but lower than the 2.2 percent forecast of economists in a Reuters survey.
Annual core inflation, watched carefully by the central bank, drifted farther from its target to 1.7 percent from 1.8 percent. It had been predicted to inch up to 1.9 percent.
"It does support the Bank of Canada's view that you get a little bit of a retrenchment in inflation, so it's kind of transitory," said David Tulk, chief Canada macro strategist at TD Securities. "It gives the Bank of Canada a little bit of reprieve."
"With core at 1.7, you're close enough to the Bank of Canada's target, and you'll get a little bit more of a reprieve in August, just given falling energy prices that month as well."
The Canadian dollar hit a session low of C$1.0982, or 91.06 U.S. cents, immediately after the data before gaining back some ground.
On a month-on-month basis, prices had been expected to retract by 0.1 percent, partly because of cheaper energy, but ended up 0.2 percent lower. Core prices, which strip out volatile items like gasoline and vegetables, showed a 0.1 percent decline instead of an expected 0.1 percent rise.
Gasoline prices did fall during the month, by 1.9 percent, but non-core areas also dropped, including clothing and health and personal care.
"It's the pullback in core inflation that's probably the most important element of today's reports," said Bank of Montreal chief economist Doug Porter.
However, Porter said it would not dramatically change the picture for the central bank, which actually predicted core inflation of 1.7 percent for the third quarter.
The central bank governor said last month the downside risks to inflation associated with a below-target starting point had diminished.
Poloz said the bank's policy stance was neutral, meaning its next interest rate move could as easily be a cut as a hike. The next rate decision is on Sept. 3.
TD Securities' Tulk said he expected a potential rate hike in the third quarter next year.
"A July move still seems to be the most likely scenario," he said. (Additional reporting by Allison Martell, Leah Schnurr and Solarina Ho in Toronto; Editing by Bernadette Baum)