OTTAWA -- Canada's inflation rate edged down to 3.8 per cent last month as price pressures eased across the economy, setting the stage for the Bank of Canada to hold its key interest rate steady next week, economists say.

Statistics Canada released its latest consumer price index report on Tuesday, which showed inflation slowing once more in September after rising to four per cent in August.

The data was a welcome surprise for economists.

The federal agency said grocery prices were up 5.8 per cent year-over-year in September compared with 6.9 per cent in August.

The report shows the main upward pressures on annual inflation last month were mortgage interest costs, rent, food purchased from restaurants, gasoline and electricity. Meanwhile, lower prices for telephone services, natural gas, air transportation, childcare and housekeeping services and furniture helped pull inflation down.

Economists reacting to the latest inflation data say that it adds more evidence that the Bank of Canada, which is gearing up for a rate decision on Oct. 25, can remain on the sidelines and wait for inflation to continue falling.

"I think the Bank of Canada will smile a little bit after this report. It takes the pressure off them heading into next week's meeting, and they should very much be on hold when they make their decision," said Benjamin Reitzes, BMO's managing director of Canadian rates and macro strategist.

The central bank's key interest rate sits at five per cent, the highest it's been since 2001.

The Bank of Canada will be paying close attention to core measures of inflation, which strip out price volatility, to gauge the direction in which inflation is headed.

The inflation report showed the central bank's preferred core measures have decelerated since August, but remain elevated.

Bank of Canada governor Tiff Macklem recently said he expects the governing council's deliberations to focus on whether the central bank should exert more patience with inflation, or act swiftly to clamp down on price growth.

Although the latest inflation numbers offer some relief for the central bank, Reitzes said before the central bank completely backs off, it will need to see inflation continue falling to the two per cent target.

"This is one report; we need to get more of this for them to really back off on their worries on inflation, but it is certainly a step in the right direction," Reitzes said.

The central bank has been fighting runaway inflation with higher interest rates since March 2022. And while inflation has not yet returned to its two per cent target, the central bank is trying to not overdo it with rate hikes, given the economy has already started to buckle under the weight of higher borrowing costs.

"The softer economic backdrop suggests we should see inflation continue to slow as we head into 2024," Reitzes said.

Since last year, economic growth has slowed significantly and the labour market is no longer as hot as it was coming out of COVID-19 lockdowns.

The Bank of Canada's most recent business outlook survey, published Monday, also shows business sentiment continued to weaken in the third quarter as companies said they expect sales growth to slow over the coming year.

As previous rate hikes continue to feed through the economy, forecasters anticipate the softness to continue. Economists estimate it can take one to two years for the full effect of a rate hike to work its way through the economy.

"The lagged impact of interest rate hikes to-date will continue to exert downward pressure on consumer spending as debt payments rise as a share of household incomes, making it more challenging for businesses to raise prices as fast and as frequent," wrote RBC economist Claire Fan in a client note.

In addition to its rate decision, the Bank of Canada will publish its latest projections for the economy and inflation on Oct. 25.

This report by The Canadian Press was first published Oct. 17, 2023.