Inflation was softer than expected in August, data revealed Tuesday, leading analysts to suggest it may persuade the Bank of Canada to hold interest rates steady in the coming months.

The headline inflation rate was 1.7% in August on a year-over-year basis, Statistics Canada said, while month-over-month consumer prices slipped 0.1%. Meanwhile, the core rate -- which strips out volatile-priced items such as food and energy -- remained unchanged at 1.6% in the month.

Market consensus was for a headline rate of 1.9% and a core reading of 1.7% in August.

The figures indicate inflation poses no threat to the economy, and at present consumer price increases are running below the Bank of Canada’s forecast. For instance, analysts indicate the core rate -- which the central bank closely watches because it excludes volatility -- will come in lower than the Bank of Canada’s forecast for 1.8% in the third quarter of 2010.

This has analysts suggesting the Canadian central bank might refrain from raising its benchmark rate again at its next meeting on Oct. 19.

The central bank sets its policy rate in an effort to attain and maintain 2% inflation.

“This report clearly indicates that inflation is becoming a swing factor for Bank of Canada. And it supports our view that the Bank of Canada will be on hold for some time,” said Jonathan Basile, vice-president of economics at Credit Suisse in New York.

In seasonally adjusted terms, core prices were flat in August, and the six-month trend has ebbed to a mere 0.3% annualized rate -- which is the lowest pace in over 25 years of data, said Douglas Porter, deputy chief economist at BMO Capital Markets.

“Inflation remains well under wraps in Canada,” he said. “If anything, some measures of core inflation trends are even lower than in the United States, where deflation chatter is rampant.”

As of Tuesday morning, markets had priced in roughly 66% odds that the Bank of Canada sits on the sidelines next month. Following the release of the consumer price data, the Canadian dollar sold off and yields at the short-end of the bond curve dropped.

The Bank of Canada has raised rates by 25 basis points at each of its last three meetings, as Canada recovered strongly from the recession. However, growth has ebbed as of late, due to a slowdown in the U.S. and global economies. Second-quarter GDP expansion was 2% annualized, down from the 5.8% reading in the first three months of 2010.

The soft inflation reading also suggested there still remains “significant amount” of excess capacity in the Canadian economy, said Toronto-Dominion Bank economists in a note.

Any further cool down in economic growth could put pressure on retailers to cut prices further to attract buyers -- particularly on big-ticket items such as cars, added TD economist Diana Petramala.

The inflation data indicated energy prices rose 5% year-over-year, following a 7.9% increase during the 12-month period to July. Excluding energy, the headline inflation was up 1.4% in August.

Homeowner’s replacement costs, which rose 5.5%, passenger vehicle insurance premiums, up 5.1%, and food from restaurants, which was up 2.5%, also pushed the inflation rate higher. However, consumers paid 2.2% less for clothing and footwear in August than they did a year earlier.