Lower car prices pushed December’s core inflation rate down to its lowest level in two years, Statistics Canada said today.

A 4.1% year-over-year drop in the price of new cars and trucks helped to keep the annual inflation rate in check as dealers tried to keep buyers from heading south of the border. Some dealers also offered an early GST discount.

The core rate—which excludes the most volatile items in the consumer price index— slipped by a 10th of a percentage point to 1.5% last month, according to today’s report. This is the lowest core reading since December 2005.

Economists had widely predicted the number would rise to 1.7%.

Today’s report shows consumer prices overall increased 2.4% between December 2006 and December 2007, slightly below the 2.5% annual gain posted in November.

Higher gasoline prices and mortgage interest costs were the main factors driving this month’s increase. Excluding gasoline prices, the all-items index increased only 1.7% during the past 12 months, posting no change from November.

These numbers come on the heels of yesterday’s Bank of Canada quarterly monetary policy update, in which the bank confirmed that it will likely make further interest rate cuts.

“Today’s inflation numbers will give the Bank of Canada plenty of room to maneuver in the current rate cutting cycle,” said Jacqui Douglas, economics strategist at TD Securities, in a note. “It will allow them to provide stimulus to the Canadian economy and cushion the blow from the slowing U.S. economy, without worrying too much about re-igniting inflation pressures.”

The central bank projects that both core and total CPI inflation will fall below 1.5% by the middle of this year before returning to 2% by the end of 2009.

“Although the Bank of Canada expects core inflation to average as low as 1.3% year over year during the first half of this year,” said Michael Gregory, a senior economist at BMO Capital Markets, in a commentary. “The double whammy of strong Canadian dollar and weak U.S. economy casts downside risk on this already very low inflation projection.”

The Canadian dollar opened Friday at US99.35¢ this morning, down marginally after a huge gain of 1.7¢ Thursday.