OTTAWA - Canada's annual inflation rate fell to one per cent in June, the lowest level in eight months, prompting analysts to predict the Bank of Canada will move cautiously on future interest rate increases.

The four-tenths of a point drop in the annual rate was widely expected, as was the 0.1 percentage point drop in prices between May and June.

The mild surprise was that underlying core inflation, which excludes the volatile energy component, edged lower by one-tenth of a point to 1.7 per cent.

Markets had been expecting the Bank of Canada core rate to edge higher to 1.9 per cent.

Canada's central bank aims to keep core inflation between one and three per cent, so June's report moves the number further to the low end of the range.

Markets barely took notice of the monthly report from Statistics Canada.

The Canadian dollar traded in a narrow band near Thursday's 96.22 cents US close following the 7 a.m. announcement.

What the lower core inflation profile suggests, however, is that central bank governor Mark Carney will feel little pressure to ramp up interest rates.

On Tuesday, the Bank of Canada increased its trendsetting rate by 25 basis points to 0.75 per cent, still well below the country's core inflation reading and regarded as extremely stimulative.

"The main point is that the bank cannot wait until inflation erupts, but this very much argues for a very cautions, low approach to unwinding the stimulus," said Sal Guatieri, an economist at BMO Capital Markets.

Most analysts believe Carney will hike the policy rate one more time this year, likely in September, to one per cent and then head back on the sidelines until 2011.

But some continue to be critical of the Bank of Canada for applying the monetary brakes -- or easing the accelerator, as the central bank would see it -- before the economy is ready to stand on its own feet.

Canada's gross domestic product followed up the strong 4.9 per cent advance in the last three months of 2009 with an even bigger jump forward of 6.1 per cent in the first quarter of this year.

The economy has not been as bouncy recently. Output growth stalled in April, and the Bank of Canada estimated this week that growth slowed to only three per cent in the second quarter, and will slow even more in the third quarter.

The central bank also predicted Canada's economy won't return to full capacity until the end of 2011.

Employment gains remain robust with a 93,000 pick-up in June, the latest data released. But Carney appeared to play down the employment indicator at a news conference on Thursday, saying income growth going forward will be weaker than previously thought.

"Higher interest rates are supposedly needed to quell inflation, but the inflation menace is essentially non-existent," said Erin Weir, an economist with the United Steelworkers union. "The slowing recovery suggests that the Canadian economy could use all of the stimulus it can get."

Weir pointed out that there is no wage inflation in Canada. In Ontario, the country's most populous province, wages are rising at a 0.8 per cent clip, he said..

Most of the downward pressure on inflation in June came from lower prices for gasoline, which slipped 2.9 per cent, and clothing and footwear, which declined 1.8 per cent.

For the past few years, the volatile energy component has pushed the overall inflation rate all over the map, taking inflation higher during the run-up of oil prices and lower when crude plunged with the 2008-9 recession. That volatility appears at an end.

Most other items measured by Statistics Canada rose, although moderately.

Food prices rose 0.7 per cent; household operations 1.2 per cent; transportation one per cent, and shelter costs 1.6 per cent as home prices increased by 5.2 per cent, but mortgage costs fell by five per cent.

Headline inflation is expected to pick up in future months due to the introduction of the harmonized sales tax in Ontario and British Columbia in July, but Carney said this week the one-time change would be ignored when setting monetary policy.

Statistics Canada said the main pressure on the core index came from higher prices for passenger vehicles, insurance, homes, and electricity and telephone services.

Regionally, Ontario experienced the biggest increase in consumer prices, which rose by 1.6 per cent. Price inflation was lowest in Manitoba, which saw an overall decrease of 0.2 per cent.