UPDATE 3-Canada Feb inflation eases on lower car prices

(Adds comments, market reaction, background)

By Louise Egan

OTTAWA, March 18 (Reuters) - Canada's annual inflation rate eased in February, leaving the Bank of Canada in a comfortable spot if it wants to follow the U.S. Federal Reserve and slash interest rates aggressively amid growing market turmoil.

Consumer prices rose 1.8 percent in February compared with a year earlier, down from 2.2 percent in January, as a smaller rise in gasoline prices and a robust Canadian dollar led to lower prices on some goods, Statistics Canada said on Tuesday.

The surprise in the report was that core inflation, which excludes volatile items like gasoline and guides monetary policy, quickened slightly to 1.5 percent in February from 1.4 percent in January, though it remained well within the central bank's comfort zone.

This was the first rise in eight months, driven by a sharp 4.8 percent rise in the cost of house repairs.

"For the Bank of Canada, what this suggests is the free ride of ever declining core inflation may be coming to an end," said Doug Porter, deputy chief economist at BMO Capital Markets.

"But I would still say that Canada has got much less of an inflation problem than basically everywhere else in the world."

The central bank is widely expected to cut its overnight interest rate at its next meeting on April 22, after having trimmed it by a full percentage point since December to 3.5 percent.

With inflation not a problem, economists expect the upcoming rate decision to be driven by concerns of financial market stability.

"Against the broader canvas of financial investment banking contagion, I don't think that the Canadian CPI is going to ruffle too many feathers in the marketplace or cause anyone to discount the probability that the Bank of Canada will be cutting rates in April," said Stewart Hall, market strategist at HSBC Canada.

The Canadian dollar CAD= rose to a session high against the U.S. dollar after the inflation report, moving to US$1.0084, valuing a U.S. dollar at 99.17 Canadian cents, from pre-data levels around US$1.0052, valuing a U.S. dollar at 99.48 Canadian cents.

Bonds were mostly unchanged at lower levels across the curve.

Most primary securities dealers surveyed in late February expected the bank to cut 25 basis points in April. But recent developments, including emergency moves by the Federal Reserve and the collapse of investment bank Bear Stearns BSC.N, have led to calls for a steeper cut.

"Stalling growth, below target core inflation and sustained strength of the Canadian dollar are expected to prompt the BoC to ease significantly, cutting the policy rate by another 50 basis points to 3.0 percent on April 22 and to 2.5 percent by this summer," said Ted Carmichael, chief Canadian economist at JP Morgan.

Sherry Cooper, chief economist at BMO Capital Markets, said on Monday the bank might even lower rates before its scheduled April meeting to match the Fed, which is expected to cut rates by as much as a full percentage point on Tuesday.