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UPDATE 2-Brazil 2017 inflation tops forecasts, but misses official target

(Adds central bank open letter in 4th paragraph)

SAO PAULO, Jan 10 (Reuters) - Brazil's 2017 inflation rate topped analysts' expectations but missed the official target range for the first time, setting the stage for interest rates to remain at all-time lows.

The benchmark IPCA index rose 2.95 percent last year, the lowest annual rate since 1998 and below the government's target of 4.5 percent, plus or minus 1.5 percentage points, state statistics agency IBGE said on Wednesday. BRCPIYECI>

The reading came in above even the highest forecast in a Reuters poll of 26 economists as food prices rebounded after seven months of declines. The median estimate in the survey was for a 2.80 percent annual rate.

Central bank policymakers will publish an open letter explaining the failure to meet the goal, as required by Brazilian law, at 5:30 p.m. local time (1930 GMT), followed by a news conference by bank chief Ilan Goldfajn.

The reading is a far cry from the rates seen early in 2016, when inflation reached 13-year highs, even as Latin America's largest economy slipped into its deepest recession in decades.

Despite faster-than-expected gross domestic product growth last year, double-digit unemployment rates and idle capacity among companies kept a lid on price hikes.

Falling food prices also weighed on inflation after a strong agricultural harvest, but the trend may have come to an end in December as food prices rose for the first time since April.

The IPCA consumer price index rose 0.44 percent from November, surpassing a median 0.30 percent forecast in the Reuters poll.

Slow inflation may allow the central bank to further trim benchmark interest rates from the current 7 percent and keep them there, bolstering the economic recovery.

Interest rate futures indicated most traders expect a final 25-basis-point cut to the benchmark Selic rate in February, with a sizeable minority betting on an additional reduction in March.

With expectations for 2018 inflation below the midpoint of the official target, the central bank looks set to take its time before raising rates again.

Still, analysts stress that consolidating low interest rates and inflation will depend on efforts to cut government spending and implement structural reforms.

President Michel Temer aims to pass a bill trimming social security spending before a presidential election in October, but much of the budget cuts will fall to his successor. (Reporting by Bruno Federowski; Editing by Robin Pomeroy and Jeffrey Benkoe)