The Bank of Canada would need to raise interest rates by as much as 125 basis points if the U.S. imposes widespread tariffs on Canadian goods, according to a new report from the Organization for Economic Co-operation and Development (OECD).

The economic fallout from a full-fledged trade war would drive inflation higher, forcing the central bank to reverse its recent trend of rate cuts, says the Paris-based global agency.

The OECD report outlines how escalating tariffs—including Washington’s proposed 25% duties on steel, aluminum, and other Canadian exports—would disrupt trade, weaken growth, and drive up consumer prices. The Bank of Canada (BoC) recently cut its benchmark interest rate by 25 basis points to 2.75%, but the OECD warns that tariffs could quickly change the outlook.

Under the worst-case scenario, the BoC would need to raise rates by 100 to 125 basis points to contain inflationary pressures.

The report also projects that Canada’s gross domestic product (GDP) will grow by just 70 bps in both 2025 and 2026, a significant downgrade of 130 basis points from the OECD’s December forecast. Uncertainty over tariffs will likely prompt Canadian businesses and households to cut spending on capital investments and durable goods.

Canaommercial real estate owners, investors and occupiers have adopted a wait-and-see approach with key investment and expansion decisions pending the effects of the tariffs over a longer period. The industrial sector has been particularly hard hit by the uncertainty.

“The combination of slowing growth and rising inflation presents a challenging policy environment,” the OECD said.

If the U.S. extends tariff exemptions beyond April 2 for goods compliant with the Canada-United-States-Mexico Agreement (CUSMA), Canada’s growth outlook could improve. In this scenario, GDP growth would rise to 1.3% in both 2025 and 2026.

Inflation is expected to accelerate if tariffs remain in place, with the OECD forecasting an increase of 110 basis points to 3.1% in 2025, before easing to 2.9% in 2026. Core inflation is also projected to reach 3.1% next year, exceeding the BoC’s target range. The OECD cautions that rising inflation expectations could lead to greater financial market volatility.

While the OECD acknowledges that the BoC could continue cutting rates in a milder tariff environment, it warns that aggressive trade restrictions would leave the central bank with little choice but to raise borrowing costs.

The report also warns that Canada will be worse off than most countries if widespread tariffs persist. Mexico and the U.S. would also be among the hardest-hit nations.

Pictured: Bank of Canada headquarters in Ottawa.

Photo: Gary A. Corcoran Arts / Shutterstock