By Fergal Smith

TORONTO The Bank of Canada's most favored measures of core inflation are likely to slow in July for the first time in 10 months as base effects work in their favor, a milestone that could sway the bank to leave rates on hold at its next policy decision.

In tracking core inflation, the BoC has been particularly focused on the annualized three-month rates of the weighted median and the trimmed mean, which filter out components with extreme price movements and are more timely than the year-over-year rates that are typically observed.

The average of those two measures would drop in July below the 3.5% to 4% range it has been stuck in since September, so long as the monthly increases are not too hot - above 0.3%, for example - Reuters calculations show.

The monthly increases for both measures have been 0.3% or less in seven of the last eight months. The exception was April. Helpfully, its heated readings will drop out of three-month calculations in July.

Such an outcome could see the BoC returning to the sidelines at its next interest rate announcement on Sept. 6, said Benjamin Reitzes, Canadian rates & macro strategist at BMO Capital Markets.

"It's a milestone along that path (of lowering inflation)," Reitzes said. "At that point you are probably more willing to let prior rate moves have their full effect and not want to push things that much further."

While data last week showed headline inflation slowing in June to an annual rate of 2.8%, within the BoC's 1% to 3% control range for the first time in over two years, an easing of underlying price pressures is required in order for the slowdown in inflation to persist, say economists.

Holding rates steady in September would not guarantee the tightening cycle has ended, economists say, noting that monthly increases of 0.2% and less for the preferred core measures would need to become commonplace for inflation to move all the way back to the BoC's 2% target.

"It would be nice to see that sort of deceleration because this is a key metric that has yet to cooperate with the Bank of Canada," said Royce Mendes, managing director and head of macro strategy at Desjardins.

The central bank raised its benchmark rate in June after a five month pause and tightened further this month, lifting it to a 22-year high of 5%, concerned about the persistence of underlying price pressures.

The BoC, which will release minutes from its July meeting on Wednesday, has said it doesn't want to tighten more than is needed. Money markets see a 25% chance of a September hike and are pricing in a 75% chance of a move by the end of the year.

Canadians are particularly sensitive to higher borrowing costs after loading up on debt in recent years as house prices soared. The July inflation data is due for release on Aug. 15.

"It will hopefully be the case that price pressures were just generally tamer in July now that the Bank of Canada has raised rates up to 5% and as time passes more mortgages renew at these higher rates, more excess savings is exhausted, more pent-up demand gets satisfied," Mendes said.

(Reporting by Fergal Smith; Editing by Denny Thomas and Jonathan Oatis)