Statistics Canada said Friday that the consumer price index rose at a annual pace of 2.7 per cent in July, down from a 3.1 per cent rate in June.
It was the first time that inflation has been below a pace of three per cent since February. TD Bank deputy chief economist Derek Burleton said the "inflation genie" appeared to remain tucked in the bottle.
"It will give the Bank of Canada some wiggle room to keep rates low during this period of global uncertainty," Burleton said.
"The thinking has shifted now to the fact that economic growth is probably going to slow and the fact that core inflation is still below the Bank of Canada's target (of two per cent) means that inflation really isn't a major risk at the moment."
The core index, which is used by the Bank of Canada to help guide its decision on interest rates, gained 1.6 per cent following a 1.3 per cent gain in June. On a month-over-month basis, the core index was up 0.2 per cent in July, in line with economist expectations.
Bank of Canada governor Mark Carney told the House of Commons finance committee that the latest read on inflation was consistent with the central bank's expectations.
Finance Minister Jim Flaherty and Carney testified before the committee on Friday following nearly two weeks of volatile trading on stock markets around the world due to fears of a sovereign debt crisis in Europe and worries that the United States may slip back into recession.
As the Canadian recovery has progressed, the central bank has emphasized that it would be prudent with respect to the possible withdrawal of any degree of monetary stimulus, Carney said.
"This is particularly important in the current environment of material external headwinds. To state the obvious, if the outlook for growth and inflation changes, the path for monetary policy will be affected accordingly," he said.
BMO senior economist Sal Guatieri noted that the core rate appeared to be on track to fall short of the Bank of Canada's estimate of 1.9 per cent for the third quarter.
"While Canadian inflation has been more volatile than usual of late, core inflation looks to settle just below the two per cent inflation target, providing an anchor for the headline rate to gravitate toward," Guatieri wrote in a note to clients.
"The tame core reading will buy the Bank of Canada time to remain on the sidelines and is clearly no obstacle for rate cuts should global recession risks intensify."
Energy prices were the main driver of the increase, gaining 12.9 per cent compared with a year ago. However, that was down from a 15.7 per cent increase in June. Gasoline prices were up 23.5 per cent compared with a year ago, compared with a 28.5 per cent increase in June.
Food prices were up 4.3 per cent, matching the increase in June.
Excluding food and energy prices, the consumer price index increased at a pace of 1.2 per cent in July, compared with a 1.4 per cent increase for June.
July was the first month to compare prices with a year ago that included the introduction of the harmonized sales tax in Ontario and B.C. as well as a two percentage point increase in the tax in Nova Scotia.
Last week, the U.S. Federal Reserve said it would look to keep its key interest rate near zero through the middle of 2013. The low rates in the United States will put more pressure on the Bank of Canada to keep borrowing costs on hold north of the border as well.
There had been recent speculation that the Canadian central bank would begin raising rates this fall to curb inflationary pressures in the Canadian economy, which has been growing faster than the United States.