The Bank of Canada today hiked its key overnight rate by 25 basis points to 3.25. The move was widely expected by market watchers.

In the wake of the announcement, the country’s big banks began raising their prime rates by one-quarter of a percentage point to 5%.

The central bank has raised rates twice this year – once in September and again in October – citing a need to keep a lid on inflationary pressures.

The latest inflation report showed the cost of living rising at 2.6% annually. But last Friday’s jobs report also revealed that the average wage rate in Canada had increased by 3.9% in the previous 12 months.

In a commentary accompanying today’s rate decision, the bank said its outlook for the economy and inflation through 2006 and 2007 is relatively unchanged from October, but sounded a warning for the longer term.

“The Bank continues to judge that the risks to the outlook are balanced over the short term, but are tilted to the downside through 2007 and beyond,” the bank said in a release.

With that in mind, the bank said further rate hikes will be required to keep the economy from overheating over the next four to six quarters and keep inflation on target.

The Bank of Canada’s next decision on interest rates is slated for January 24.