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OTTAWA (Reuters) - Canada's annual core inflation rate dropped in March to 1.7 percent from 2.1 percent, in part because prices for travel and accommodation dipped after the Winter Olympics, reducing the odds of aggressive near-term rate hikes by the Bank of Canada.
Market operators had predicted the closely watched core rate -- which excludes volatile items like gasoline -- would dip to 1.9 percent in March. Core CPI fell 0.2 percent in the month, Statistics Canada said on Friday.
The Bank of Canada this week dropped a conditional pledge to keep interest rates on hold at least until the end of June and also predicted core inflation was set to stay close to its 2.0 percent target.
"After a stream of high side surprises in Canadian inflation, we've seen a very clear break to the downside ... it is a fairly significant downside surprise," said Doug Porter, deputy chief economist at BMO Capital Markets.
"(It's) not a complete shock given that many of the upside surprises in recent months were seen as temporary. But still I think it will be major source of reassurance for the Bank that there isn't something really unusual going on in core inflation."
The Bank of Canada has the option of hiking rates in both June and July but governor Mark Carney on Thursday declined to be more specific about when or whether the central bank would move.
The Canadian dollar weakened following the data, hitting a session low of C$1.0050, or 99.50 U.S. cents, up from C$1.0003, or 99.97 U.S. cents just before the report.
Overnight index swaps, which trade based on expectations for the Bank of Canada's key policy rate, edged lower after the announcement, showing the market saw tightening as slightly less likely than before the data.
Still, the market was pricing in more than a 90 percent probability that the central bank hikes interest rates by 0.25 percent in June.
"I don't think it (the March inflation report) completely changes the landscape but at least in casts a shadow of a doubt on whether June is a done deal," said Porter.
In a Reuters poll on Tuesday, 11 of Canada's 12 primary dealers predicted a rate hike of 25 basis points on June 1.
The central bank has identified price rises related to the Olympics -- which were held in British Columbia in the second half of February -- as a factor that would temporarily boost the inflation rate.
Overall inflation did not change in March over February while in the 12-month period it eased to 1.4 percent from 1.6 percent. Recreation prices -- a category which includes hotel rooms and travel tours -- fell by 0.7 percent from March 2009 compared to a 2.4 percent year-on-year increase in February.
With additional writing by Jeffrey Hodgson