By Paul Vieira 

OTTAWA -- Canada's annual inflation rate slowed sharply in March after two months at or above 2%, in line with a widespread pullback in inflation expectations following a jump in the wake of Donald Trump's U.S. election victory last fall.

The inflation report could reinforce the Bank of Canada's cautious approach to the economic outlook, and its message that considerable slack, or unused labor and production capacity, continues to weigh on wages and prices.

The all-items consumer-price index in March increased 1.6% from a year earlier, Statistics Canada said Friday, compared with a 2% rise in February and a 2.1% advance in January. Market expectations were for a 1.8% increase in March, according to economists at Royal Bank of Canada.

On a month-over-month basis, CPI in March rose 0.2%.

Two of the three gauges of underlying, or core, inflation also advanced at a slower pace compared with the previous month. All of them remain below the 2% mark -- in a range between 1.3% and 1.7%. The Bank of Canada sets rate policy to achieve and maintain 2% inflation.

In its most recent economic forecast, the central bank said the core readings below 2% are consistent with "material excess capacity" in the Canadian economy.

The slowdown in Canadian inflation comes as investors in the U.S. pare back expectations, after enthusiasm over Mr. Trump's plans for tax cuts and infrastructure spending drove investors into riskier assets, notably stocks, and out of fixed income. Yields on U.S. government debt rose, which is generally a sign that traders are betting higher inflation is in the offing.

But a reversal has unfolded in recent weeks, partly due to concerns how quickly Mr. Trump can implement his agenda. The U.S. bond market is now pricing in less inflation in the coming years, with break-even rates -- or the difference between nominal and inflation-adjusted Treasury yields -- drifting to their lowest levels since November.

Meanwhile, Bank of Canada Gov. Stephen Poloz has held to a cautious overview of the economy amid a recent spate of positive economic data. In the central bank's last interest-rate decision, it said recent indicators signaling stronger-than-expected growth were due to temporary factors, and it expected growth to slow beginning in mid-2017.

Bank of Canada expects annual inflation to return to the 2% level in the first half of 2018 as spare capacity in the economy is gradually absorbed.

As for March's inflation report, five of the eight components Statistics Canada tracks recorded increases in prices.

Transportation costs rose 4.6% from a year ago, a slowdown after a 6.6% climb in the previous month. Gasoline prices rose 15.2%, following a 23.1% rise in February. Meanwhile, total shelter costs rose 2.2%. The homeowners' replacement cost -- or the price to maintain a residence at its current market value -- rose 4%.

Food prices declined for a sixth straight month, down 1.9% in March on a 12-month basis. The cost of fresh vegetables fell 10.2%; fresh fruit, down 12.4%; and meat, down 3%.

Excluding food and energy, annual inflation rose 1.7% in March.

On a seasonally adjusted basis, Canada's CPI fell 0.2%.

Write to Paul Vieira at paul.vieira@wsj.com

(END) Dow Jones Newswires

April 21, 2017 09:11 ET (13:11 GMT)