The Bank of Canada raised its key interest rate by one-quarter of a percentage point this morning, as widely expected.

The key lending rate is now to 3.5%

However, the central bank also warned that it may raise rates several times more as it tries to keep inflation in check.

“The bank continues to judge that the Canadian economy is operating at its production capacity and will grow roughly in line with production potential through 2007,” David Dodge, governor of the Bank of Canada, said in a statement before markets opened Tuesday morning

“In line with the bank’s base-case projection, some modest further increase in the policy interest rate would be required to keep aggregate supply and demand in balance and inflation on target over the medium term.”

Today’s increase marks the fourth time in recent months that the central bank has raised rates to head off inflation.

Many analysts expect another rate hike on March 7.

Overall inflation averaged 2.3% in the fourth quarter of 2005 and should return to about 2% by early 2007, the central bank said.