By Promit Mukherjee and David Ljunggren

OTTAWA (Reuters) – The Bank of Canada on Wednesday trimmed its key policy rate by 25 basis points to 3%, cut growth forecasts, and expressed concern that U.S. tariffs could stoke persistently high inflation.

U.S. President Donald Trump is promising to impose a 25% tariff on all imports from Canada on Saturday. Canada sends 75% of all goods and services exports to the United States.

“A long-lasting and broad-based trade conflict would badly hurt economic activity in Canada,” said Bank of Canada Governor Tiff Macklem. The prospect of such a war is clouding the economic outlook.

Macklem noted that a significant increase in tariffs would have an immediate, one-off impact on Canada that monetary policy could not adequately counter.

“What we don’t want to see is that initial price level increase start to feed through broadly to other prices and wages and then become persistent inflation,” he explained.

If inflationary pressures arise faster than deflationary ones, “monetary policy is going to have to be more focused on guarding against persistent inflation,” he said, without specifically mentioning the possibility of higher rates.

Macklem warned that a tariff war triggered by the United States could cause major economic damage.

In a hypothetical scenario presented in its monetary policy report, the bank stated that if Canada and other nations imposed a retaliatory 25% tariff on the United States, this could cut Canadian growth by 2.5 percentage points in the first year and another 1.5 percentage points in the second year.

Wednesday’s cut marked the sixth consecutive time the bank has reduced borrowing costs. Inflation has consistently stayed around the mid-point of the bank’s 1-3% target range, but economic growth remains sluggish.

“With inflation around 2% and the economy in excess supply, the Governing Council decided to reduce the policy rate further by 25 basis points to 3%,” the bank stated.

The Canadian dollar weakened immediately after the decision but later traded near flat against the U.S. Dollar.

Money markets see over a 43% chance of another 25-basis-point cut during the BoC’s next monetary policy decision announcement on Mar. 12.

“The Bank of Canada would be in a tough situation, but our view is that they would become more aggressive in terms of rate cuts if that’s what we’re faced with,” said Doug Porter, chief economist at BMO Capital Markets.

The bank’s challenge lies in the potential for U.S. tariffs to drive up inflation, theoretically necessitating higher rates, while simultaneously cutting growth, which could suggest the need for more stimulus through lower rates.

“With a single tool – our policy interest rate – we can’t lean against weaker output and higher inflation at the same time,” Macklem stated. The bank could, however, help the economy adjust, especially given that inflation levels are low, he noted.

The bank also announced the end of its quantitative tightening program in March, which aimed to drain the excess liquidity pumped into the economy during the pandemic.

The BoC, known for its aggressive stance among central banks, has revised its economic growth outlook to 1.8% for 2025, down from 2.1% predicted in October, and to 1.8% for 2026, down from a previous forecast of 2.3%.

The central bank slightly raised its inflation forecast to 2.3% from 2.2% for 2025, and to 2.1% from 2.0% for 2026. These projections do not factor in potential U.S. tariffs.

Canada’s economy has been contracting on a per-capita basis for six continuous quarters, primarily supported by population growth. However, with the federal government’s new immigration restrictions, Canada could face a 0.2% population decline in both 2025 and 2026.