After leaving the 33-year-old at home during Euro 2012 over the summer, Hodgson has once again overlooked the centre-back for the upcoming World Cup qualifiers against San Marino and Poland.
And Pallister insists the "authoritative" defender still has plenty to offer, believing the decision could come back to haunt the former Liverpool boss.
"I watch Rio every other week, and I think he's still a class apart. And I think Roy has probably got it wrong," Pallister told The Mirror.
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"For me, Rio should still be in the squad. You have lost a vast amount of experience in there with John Terry's retirement and I think that Rio still has a lot to offer the England cause.
"We didn't look so great at the back in the last internationals. Of course, Rio has lost some pace - and he's going to lose it because he's coming up to his 34th birthday.
"I played alongside Steve Bruce, and he was the first to say he didn't have great pace, but it was all about reading the game - the timing of a tackle, being in the right place at the right time.
"Look at Bobby Moore - he didn't have blistering pace. Rio is a class act, he reads the game better than any other English centre-half, in my opinion.
"He showed that against Newcastle, where he snuffed everything out and played to the best of his ability.
"Without John Terry and Rio, I think we lack an authoritative figure in that back four."