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UPDATE 2-Canada inflation hits 10-month high on gasoline

* Gasoline prices push inflation higher in December

* Bank of Canada unlikely to abandon pledge to hold rates

* Inflation rate below market expectations (Adds market reaction, analysts)

OTTAWA, Jan 20 (Reuters) - Higher gasoline prices pushed Canada’s annual inflation rate to a 10-month high in December, but the data is unlikely to knock the Bank of Canada off track in its pledge to hold interest rates steady for some time.

The consumer price index (CPI) slipped 0.3 percent in December from November, Statistics Canada said on Wednesday. But 12-month inflation was 1.3 percent, the highest since 1.4 percent in February 2009, due largely to the base effect of a steep decline in gasoline prices in December 2008. In November, annual inflation was 1.0 percent.

Still, the data was below market expectations, and inflation was in the lower end of the Bank of Canada’s target range of 1 percent to 3 percent.

Analysts in a Reuters poll forecast a monthly decline of 0.2 percent in the CPI and 12-month inflation of 1.5 percent.

“The weakness in the data takes any kind of pressure off of the Bank of Canada to potentially act sooner rather than later, so I think from a shorter term perspective we might see a little more Canadian dollar weakness in reaction to that,” said George Davis, chief technical strategist at RBC Capital.

The Canadian dollar weakened to a session low of C$1.0435 to the U.S. dollar, CAD= or 95.83 U.S. cents, from C$1.0388, or 96.26 U.S. cents just before the release.

Yields on overnight index swaps, which trade based on expectations for the key rate, edged lower after the report, showing the market saw monetary tightening as slightly less likely.

INFLATION BENIGN BY WORLD STANDARDS

Core CPI, closely watched by the central bank, also came in slightly weaker than expected with a decline of 0.3 percent in the month for an annual rate of 1.5 percent, below the market forecast of 1.7 percent.

Doug Porter, deputy chief economist at BMO Capital Markets, called the report “benign.”

“The key here is that both headline and core prices fell on the month. Even in seasonally adjusted terms prices dipped and compared with most of the rest of the industrialized world, Canada’s inflation rate looks quite subdued,” Porter said.

The central bank noted on Tuesday that core inflation had been slightly higher than it expected in recent months -- it was 1.5 percent in November and 1.8 percent in October. But the bank showed little concern about the trend and said it expected overall CPI and core CPI would reach its 2 percent target in the third quarter of 2011.

The bank kept its key overnight rate on hold at a historic low of 0.25 percent and repeated its pledge to keep it at that level through the end of June, conditional on inflation staying tame.

It noted that “considerable excess supply” remains in the economy, suggesting it was not worried about inflation just yet. The bank will provide more details on its outlook in a quarterly report on Thursday.

Gasoline prices explained much of the 12-month rise in the CPI in December for the second straight month, Statscan said. Gasoline jumped 25.6 percent from a year earlier, and energy prices overall climbed 5.9 percent.

Six of the eight CPI components rose in the 12 months, with the exception of shelter, clothing and footwear.

On a monthly basis, clothing discounts and household operations and furnishings contributed most of the downward pressure. The clothing and footwear sector reported a 4.7 percent decrease in prices. (Reporting by Louise Egan; editing by Randall Palmer and Jeffrey Benkoe)

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