Bank of Canada Could Raise Interest Rates by up to 1.25 Percent Due to Tariffs: OECD Report

The flags of Canada and the United States fly outside a hotel in downtown Ottawa, on Feb. 1, 2025. The Canadian Press/Justin Tang

Inflation caused by tariffs could force the Bank of Canada to raise interest rates by up to 1.25 percent, a level that exceeds those in many other countries, a new report suggests.

“Together with the rise in domestic tariff rates, this results in tighter monetary policy than otherwise in other countries, particularly those whose currencies have depreciated against the U.S. dollar,” reads the report by the Organisation for Economic Co-operation and Development (OECD).

Interest rates would rise by 0.25 percent to 0.5 percent on average in other “advanced and major emerging market economies,” the OECD said.

The growth outlook for most of the 38 countries was cut back in the March 17 report, with global growth predicted to slow to 3.1 percent in 2025 and 3 percent in 2026 due to higher trade barriers and geopolitical and policy uncertainty impacting investment and household spending.

GDP growth in Canada is expected to slow from 1.5 percent in 2025 and 2026 to 0.7 percent in both years. The report projects that inflation in Canada will also be at 3.1 percent in 2025 and 2.9 percent in 2026.

If the United States hits all imports from Canada and Mexico with 25 percent tariffs, and the countries respond with retaliatory tariffs, it will be “particularly costly for Canada and Mexico” due to their high proportion of trade with the United States, the report said.

The United States will also see its GDP growth slow to 2.2 percent in 2025 and 1.6 percent in 2026, while inflation is projected to be 3 percent in 2025 and 2.6 percent in 2026.

The United States imposed 25 percent tariffs on Canada and Mexico on March 4, but implemented a one-month exemption for products compliant with the United States-Mexico-Canada Agreement (USMCA). If this pause were to be extended, the report projects inflation would be lower in all three countries, reaching 2.6 percent in 2025 and 2.5 percent in 2026 in Canada, and 2.7 percent in 2025, and 2.5 percent in 2026 in the United States.

The report said tariff revenues will amount to roughly 1.2 percent of U.S. GDP and 1.5 percent of Canada’s GDP, but this would be “offset by the associated decline in activity and higher debt servicing costs.” It said the impact of tariffs on public finances could mean there is “little scope” to use these revenues to lower taxes or increase spending.

After the United States imposed 25 percent tariffs on Canada, Ottawa retaliated with 25 percent tariffs on $30 billion worth of U.S. goods, with another $125 billion of imports to be tariffed after 21 days. The second round of tariffs was put on hold after Washington announced a one-month pause of tariffs on exports compliant with the USMCA.

Ottawa has said that revenues collected from retaliatory tariffs will be used to support Canadians harmed by U.S. tariffs.

The Bank of Canada announced on March 12 that it had brought its key interest rate down by 25 basis points to 2.75 percent, marking the seventh consecutive cut amidst “uncertainty” about the U.S. trade war. The bank said the trade war is expected to reduce economic activity, force businesses to reconsider hiring and investing, and increase inflation.