OTTAWA, Ontario: The Bank of Canada raised its benchmark interest rate by 25 basis points to 2.5% on Wednesday, its first increase in more than three years, as higher energy costs pushed up inflation and raised concerns about broader price pressures.

The increase was widely expected. The central bank also sharply raised its inflation forecast for 2027 to 3.1% from the 2.0% projected in July.

Growth this year is now expected at 1.0%, up from the bank's July forecast of 0.7%.

"With the outlook for inflation substantially higher and the economy showing resilience, an increase in the policy rate is needed to reduce the risk that elevated energy prices could spill over and become generalized inflation," Governor Tiff Macklem said in opening remarks to reporters.

"There could be a need to increase the policy rate further, but given uncertainties, we will proceed carefully."

The rate increase is likely to push up bank lending rates and mortgage costs and could slow economic growth. Macklem said the bank's priority was to keep costs contained.

"Higher interest rates aren't going to immediately feel like they are helping," Macklem said.

"What is the best thing we can do for Canadian households and Canadian businesses... is that we can get inflation down," he said.

Canada's annual inflation rate reached 3.2% in September, above the central bank's 1%-3% target range, driven almost entirely by higher energy and energy-related transportation costs.

Macklem said inflation was expected to end the year at 3.5% and remain around 3% for most of next year before returning close to the 2% target by the middle of 2028.

Wednesday's rate hike was the first since July 2023. Despite the increase, the policy rate remains below the midpoint of the neutral rate, which the Bank of Canada puts at 2.75%.

Macklem said he would not prejudge where the policy rate should be in the coming months.

"There could be a need to increase the policy rate further, but we are very mindful that there is a lot of uncertainty and against that background there is no predetermined path," he said.

"We don't expect that core measures of inflation will accelerate as much as the Bank fears, particularly if global energy prices ease a little, and as a result we don't think that the policy rate will need to move above 2.75%," said Andrew Grantham, senior economist at CIBC Capital Markets.

Macklem said past experience and Bank of Canada surveys suggest cost pass-through will increase over the next year, adding to overall inflation.

Economists who opposed an increase have pointed to core inflation remaining around 2% and argued that higher rates could hinder the modest economic recovery amid U.S. trade tensions and a weak job market.

Macklem said new U.S. tariffs would slow the economy in the fourth quarter, but expressed confidence that growth would pick up again in 2027 as consumer spending continues, exports increase and business investment strengthens.

After annualized growth of 3.3% in the second quarter, the economy is expected to slow to 2% in the third quarter and 0.8% in the fourth, according to the bank's new monetary policy report.

The bank raised its GDP forecasts for 2027 and 2028 to 2% from the 1.8% projected for both years in July.

The Canadian dollar firmed slightly to C$1.4050 to the U.S. dollar, or 71.17 U.S. cents.

The Bank of Canada's next rate decision is scheduled for December 9.