Bank of Canada holds rate at 2.25 percent as it sees signs of improvement

Canada's central bank kept its key lending rate at 2.25 percent on Wednesday, saying the economy is showing signs of improvement while warning that uncertainty over US trade policy and the Middle East conflict remain risks.

The Bank of Canada said businesses are adapting to new trade conditions under US President Donald Trump. Canada's economy had weakened over the past year as US tariffs hit sectors including auto-making, led to job losses and unsettled businesses. The country entered a technical recession earlier this year after two consecutive quarters of economic contraction.

Bank of Canada Governor Tiff Macklem said uncertainty around US trade policy remains a headwind, but that consumers have been resilient and businesses are adjusting. He said exports are increasing as companies look for ways to operate while US free trade remains restricted in several sectors.

Macklem said businesses are reconfiguring supply chains and that a strong US economy is supporting demand for Canadian exports. He said US businesses are increasing orders for Canadian goods.

Trump refused on July 1 to renew the North American free trade agreement, but the agreement remains in force while the United States, Canada and Mexico negotiate revised terms. The continued operation of the deal, known as USMCA, means about 85 percent of US-Canada trade has remained tariff free.

Prime Minister Mark Carney has warned that US trade will not return to its previous pattern and has urged Canada to pursue new overseas markets. Macklem said there are signs of that shift, including in aluminum, a major Canadian sector facing Trump tariffs, where he said businesses are finding new customers in Europe.

Macklem also said conflict in the Middle East is a key risk, with hostilities between the United States and Iran resuming after a short ceasefire. The central bank has said it would not overreact to energy price inflation caused by the conflict and would raise rates only if higher oil prices were clearly spreading into other parts of the economy.

Macklem said the bank has not yet seen broad spillovers from higher energy prices. He said the length of time oil prices stay high would matter, and that signs of war-related inflation causing wider price increases would be a warning sign that could require interest rate hikes.