A man pumps fuel into his car at a gas station in Toronto April 22, 2014. REUTERS/Mark Blinch/File Photo

By Promit Mukherjee

OTTAWA (Reuters) -Canada's annual inflation rate eased to 1.7% in July from 1.9% in the prior month as lower year-on-year gasoline prices kept the consumer price index low, data showed on Tuesday.

Economists also cheered the three-month average of the core measures, which eased to below 3% after several months, boosting hopes of a rate cut in September.

Analysts polled by Reuters had forecast the annual inflation rate at 1.8% and the monthly inflation rate at 0.3%. The CPI increased by 0.3% in July from 0.1% in June on a monthly basis, Statistics Canada said.

Gasoline prices dropped by 16.1% on a yearly basis in July, following a 13.4% decline in June. On a monthly basis the price of the fuel dropped as geopolitical tensions eased and crude oil-producing nations increased output.

The elimination of a carbon levy on petrol purchases has helped bring down the cost of the fuel on a yearly basis and is expected to maintain downward pressure on the CPI basket for another eight months.

The overall consumer price index has held below the mid-point of the Bank of Canada's 1% to 3% target range, even as there are signs of rising prices of food.

Excluding gasoline, the CPI rose 2.5% in July, StatsCan said.

Core measures of inflation, which are closely tracked by the Bank of Canada, have remained resilient and hovered around the top of the bank's preferred range of CPI.

The share of the CPI basket which is above 3% continues to be elevated at over 37%, data showed.

The average of the three months of annualized core measures slipped to 2.4% in July, the first time since September last year, said Doug Porter, chief economist at BMO Capital Markets.

"If that more recent pace in core is maintained, and the economy remains soft, we believe that will eventually set the stage for BoC cuts," he said, but cautioned the three-month annualized metric could swing wildly with one month of aberration in data.

Money markets are betting the odds of a rate cut on Sept. 17 at 40%, up from 32% before the inflation data, after the bank has stayed put at 2.75% for its last three rate decision meetings.

The Canadian dollar weakened and was trading down 0.23% after the inflation data. Two-year government bond yields were down 3.5 basis points to 2.704%.

The main drivers of the increase in costs were a rise in food prices and shelter costs, StatsCan said. Food prices, which contributes close to 17% to the overall CPI basket, rose by 3.3% in July from 2.9% in June.

Shelter costs, the biggest component of the CPI basket, rose 3% in July from 2.9% in June, marking the first increase since February last year.

(Reporting by Promit Mukherjee; Editing by Dale Smith, Mark Potter and Franklin Paul)