Inflation forecast for Cyprus revised sharply upwards to 3.2 per cent

The Central Bank of Cyprus (CBC) has lowered its growth forecasts for the Cypriot economy for 2026 and 2027, pointing to the impact of the war in the Middle East and warning that risks remain tilted to the downside.

In its June 2026 economic bulletin, the CBC said it now expects GDP to grow by 2.5 per cent in 2026, down from the 2.7 per cent forecast in March. Growth in 2027 was also revised slightly lower, to 2.9 per cent from 3 per cent, while the economy is expected to accelerate to 3.1 per cent in 2028. 

The central bank said the relatively limited impact on this year’s forecast was because some conservative estimates had already been incorporated in the March projection round. 

However, it warned that “the main downside risks to GDP” are linked to the possible non-finalisation or non-implementation of the agreement announced between the United States and Iran. 

The CBC said its baseline scenario had been completed before that announcement and was based on the working assumption that the conflict would continue until the final quarter of 2026 before gradually easing. 

It noted that if the US and Iran do not maintain their commitments and the agreement is not implemented, risks would remain around possible fuel shortages, quotas, further disruption to energy and raw material production, and higher-than-expected energy and import prices caused by supply chain problems.

The bank said ongoing geopolitical tension, together with the sharp rise in international oil prices, is expected to affect the Cypriot economy through weaker domestic and external demand. 

These pressures are expected to be more visible in sectors such as tourism, shipping, construction and real estate, particularly because several of them depend heavily on foreign investment inflows. 

For 2026, the CBC expects net exports to make a negative contribution to growth, mainly because of lower tourism revenues. 

At the same time, shipping revenues are also expected to fall as a result of disruption caused by the conflict, while exports of other services are forecast to grow at a slower pace because of the less favourable external environment. 

Imports are also expected to slow, reflecting weaker domestic demand. The CBC said, “net exports should turn positive again in 2027 and 2028, mainly on the back of an expected recovery in tourism, despite the increase in imports.” 

Domestic demand, meanwhile, is expected to remain supported by private consumption, helped by higher real disposable household income and the continued resilience of the labour market, despite stronger inflationary pressures. 

The CBC also said that “large private non-residential investment projects should continue to support the economy, even though their implementation schedules may be affected by the crisis.” 

“Although their implementation schedule may be affected by the crisis in the Middle East, these projects are not expected to be cancelled,” the bank said, citing the temporary nature of the geopolitical instability and the long-term horizon of their completion. 

On inflation, the CBC revised its forecast sharply upwards. It now expects inflation, based on the harmonised index of consumer prices, to rise to 3.2 per cent in 2026, compared with 0.8 per cent in 2025. 

This represents an upward revision of 0.5 percentage points compared with the March forecast and is mainly linked to the economic effects of the war in the Middle East. 

Inflation is then expected to decline to 1.9 per cent in both 2027 and 2028, mainly because of a downward base effect on energy prices, as well as a gradual slowdown in services and, to a lesser extent, food prices. 

The CBC said “energy prices are expected to face significant upward pressure this year because of higher international oil prices, linked to restrictions in passage through the Strait of Hormuz.” 

These pressures are also expected to feed through to other inflation categories. 

Industrial goods, excluding energy, are still expected to record deflationary pressures, although these are likely to be smaller than in 2025 because of supply chain disruption and higher production costs. 

Food prices are also expected to come under pressure, mainly because of higher fertiliser prices linked to supply chain problems. 

The CBC also noted that inflation in 2028 includes the expected impact on energy prices, particularly motor fuels, from the introduction of the EU’s expanded Emissions Trading System, known as ETS2. 

Core inflation, which excludes energy and food, is forecast to rise to 2.3 per cent in 2026, from 1.9 per cent in 2025, before easing to 2.2 per cent in 2027 and 1.9 per cent in 2028. 

The central bank said the increase this year reflects higher services inflation and stronger prices for industrial products, largely because of the indirect effects of higher energy costs. 

It also warned that inflation risks remain tilted to the upside, particularly if oil prices stay structurally higher because the US-Iran agreement is not finalised or fully implemented. 

Other upside risks are linked to climate-related factors, including extreme weather events, as well as the impact of green taxes under changes to European legislation. 

Higher-than-expected wages, due to the tight labour market, and stronger-than-expected business profit margins could also push inflation higher. 

On the labour market, the CBC said employment is expected to grow by 1.3 per cent in 2026, slowing from 1.7 per cent in 2025, mainly because of the effects of the Middle East crisis. 

Employment growth is then expected to accelerate to 1.5 per cent in 2027 and 1.7 per cent in 2028. 

The unemployment rate is projected to rise marginally to 4.6 per cent in 2026, reflecting the impact of the Middle East crisis, although this is expected to be limited by the tight labour market. 

For 2027 and 2028, unemployment is expected to stabilise at around 4.5 per cent, a level the CBC said reflects full employment conditions. 

Nominal expenditure per employee, including wages and social contributions, is expected to slow to 2.7 per cent in 2026, from 4.2 per cent in 2025. 

The CBC said this reflects developments in both the public and private sectors, partly because low inflation in 2025 limits the range of cost-of-living allowance payments (CoLA). 

However, wage-related expenditure is expected to strengthen again after that, supported by the path of inflation and the gradual return of CoLA to 100 per cent from July 2027. 

Productivity is also expected to keep rising throughout the forecast period, although at a slower pace than in 2025, when it stood at 2.1 per cent. 

The CBC expects productivity growth to average around 1.3 per cent per year, supported by the contribution of foreign-owned companies, mainly in the technology sector, the inflow of skilled labour and investments carried out through the EU recovery and resilience plan. 

Finally, unit labour costs are expected to slow in 2026, reflecting contained expenditure per employee and continued productivity growth, before moving close to 2 per cent in 2027 and 2028, in line with the recovery in wage-related spending.