OTTAWA--The Bank of Canada left its main interest rate unchanged on Wednesday at 2.25% as it presented what Gov. Tiff Macklem called a "fairly positive" outlook for an economy that has stagnated under the weight of U.S. trade policy and conflict in the Middle East.

Alongside its rate decision, the central bank offered an updated outlook which predicts growth to ramp up markedly in the second quarter and remain in positive territory through 2028. This marks a turnaround after the economy contracted in three of the last four quarters that prompted talk about a recession. The level of Canada's gross domestic product, as of the first quarter, is largely unchanged from early 2025, reflecting struggles to adapt to hefty U.S. tariffs on key industrial sectors, and heightened business uncertainty about the future of trading ties with Washington.

"When we talk to businesses, what we're hearing is they're adapting to this uncertainty," Macklem said at a press conference after officials left the central bank's main interest rate unchanged for a sixth consecutive policy decision. The U.S. did not this month renew the existing North American trade pact, but it still remains intact for another decade--and as a result the bulk of Canada's U.S. exports are exempt from tariffs.

Macklem said the economy appears to be firmly in expansion mode, buoyed by resilient households and a pickup in exports--the latter of which are aided by a weaker Canadian dollar and demand from a strong U.S. economy.

The Bank of Canada anticipates 2.5% annualized growth in the second quarter after the previous quarter's 0.1% decline, and a 1.5% jump in the third quarter. The central bank said much of this strength reflects the unwinding of temporary factors that restrained growth in the first quarter. "Sources of economic growth appear to be broadening," Macklem said. All told, growth in 2026 is expected to hit 0.7%, or sharply below the central bank's previous call for a 1.2% increase. The Bank of Canada projects growth of 1.8% in both 2027 and 2028.

Central bank officials have a faced an acute policy dilemma in recent months in how to support an economy operating below potential while guarding against the risk of heightened inflation posed by the U.S.-Iran conflict. Oil-tanker travel has largely come to a halt through the Strait of Hormuz since the start of the war in late February. Energy prices began to ease last month after Washington and Tehran reached a tentative deal, but started to march upward again after military attacks resumed.

"The Bank of Canada's latest hold suggests it believes it has found the right balance," says David-Alexandre Brassard, chief economist for the Chartered Professional Accountants of Canada, a lobby group. "The policy rate is high enough to keep inflation in check, but not so restrictive that it significantly constrains economic growth."

The central bank sets interest rates to achieve and maintain 2% inflation. Bank of Canada officials said that the recent rise in inflation--accelerating to 3.2% in May--is mostly attributable to an increase in gasoline prices. Macklem said inflation is expected to stay elevated in June, and then ease gradually toward 2.5% in the second half of this year.

There is room to grow before triggering inflationary pressures, Macklem said, citing the excess slack that still remains in the economy following a prolonged period of weakness.

Excluding gasoline, total inflation has stayed close to its 2% target, the central bank said, adding that the same goes for measures of core prices. "This suggests that, so far, spillovers to the prices of other goods and services remain contained," the central bank said in its quarterly economic forecast.

Macklem said there is a risk that higher energy prices begin to spill over and lift the costs of other goods and services the longer the Mideast conflict drags. Crude oil is trading in the high $70-a-barrel range, which is roughly 16% higher than late June but below the $120 peak reached in April. "Inflation is very concentrated in gasoline," Macklem said, adding policymakers would be on the lookout for evidence that price increases are spreading.

"There is a progression from broadening to persistence. And if that happens, we may well need to raise interest rates," the governor added. "That's not our base case, but it is a serious risk."

Write to Paul Vieira at paul.vieira@wsj.com

(END) Dow Jones Newswires

July 15, 2026 12:25 ET (16:25 GMT)

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