Patsalides says Cyprus must remain vigilant as inflation risks rise

Central Bank of Cyprus governor Christodoulos Patsalides has warned that a prolonged energy shock is intensifying inflationary pressures and increasing risks to the economic outlook, as the European Central Bank (ECB) keeps interest rates unchanged and Cyprus continues to experience elevated price growth.

In a statement following the ECB’s monetary policy decision on Thursday, October 29, Patsalides said the euro area faced a more prolonged period of elevated inflation, while Cyprus’ economic resilience, sound public finances and strong banking sector were helping the country withstand the effects of rising prices.

“The prolongation of the energy shock, the deterioration in the inflation outlook and the ECB’s commitment” were the defining features of the current situation, he said.

The ECB’s Governing Council decided to leave its three key interest rates unchanged, with the deposit facility rate at 2.50 per cent, the main refinancing rate at 2.65 per cent and the marginal lending facility rate at 2.90 per cent.

The decision followed September’s 0.25 percentage point increase, as the conflict in the Middle East continued to push energy prices higher and threaten both inflation and economic growth.

Patsalides said geopolitical tensions and the associated energy shock were continuing to intensify price pressures, with euro area inflation rising to 3.8 per cent in September from 3.2 per cent in August, largely because of higher energy prices, particularly petroleum products.

According to the ECB, energy inflation in the euro area climbed to 18.9 per cent in September from 14.3 per cent in August, while inflation excluding energy increased to 2.3 per cent from 2.1 per cent.

Services inflation also edged higher, reaching 3.2 per cent, compared with 3 per cent in August, while food inflation rose to 1.3 per cent from 1.1 per cent.

Diesel and petrol prices reached new peaks during September, partly reflecting higher refining margins, adding to the pressure on households and businesses.

Despite the deterioration in the inflation outlook, Patsalides said the tightening of financial conditions was helping to contain the extent to which energy-related price increases were spreading throughout the wider economy.

This tightening reflected both the transmission of previous monetary policy rate increases and a significant rise in long-term government bond yields, amid growing concerns about the sustainability of global public debt.

“So far, the indirect effects of the energy shock have remained relatively limited, while meaningful second-round effects have yet to emerge, as reflected in the latest developments in wage indicators,” he said.

Inflation expectations in international financial markets and relevant surveys also remained broadly contained, particularly over the medium and longer term, he added.

The ECB similarly said underlying inflation had remained broadly stable and wages had not yet shown a material response to the energy shock.

However, it warned that the increasing magnitude and duration of the energy shock could eventually drive inflation higher and weigh on economic growth through indirect effects and further price and wage increases.

Economic activity across the euro area had continued to demonstrate resilience, Patsalides said, although elevated uncertainty and more restrictive financing conditions were expected to weigh on growth in the period ahead.

The ECB has reiterated its commitment to bringing inflation back to its medium-term target of 2 per cent, while emphasising that future interest rate decisions would depend on incoming economic and financial data rather than a predetermined path.

“In light of the new data and our overall assessment, we judged that maintaining the key interest rates at their current levels allows the ECB to manage the prevailing uncertainty effectively, while remaining firmly committed to returning inflation to, and maintaining it at, the medium-term target of 2 per cent,” Patsalides said.

Cyprus faces elevated inflation

Turning to the domestic economy, Patsalides said Cyprus continued to demonstrate remarkable resilience despite heightened geopolitical uncertainty, supported primarily by robust domestic demand, favourable labour market conditions and sound public finances.

Nevertheless, inflation remained elevated at 5.2 per cent in September, driven largely by significant increases in energy prices and services costs.

Energy prices rose by 21 per cent, while services inflation reached 7.1 per cent, reflecting persistent pressure in these components of the domestic price basket.

There were also signs that underlying price pressures were beginning to ease, with core inflation, which excludes energy and food, declining to 3.9 per cent in September from 4.5 per cent in August.

Despite this moderation, Patsalides warned that risks to the inflation outlook remained tilted to the upside, underlining the need for continued vigilance and close monitoring of developments.

“In an environment of persistent inflationary pressures, economic resilience becomes a factor of critical importance, acting as an essential buffer against the cumulative effects of rising prices and helping preserve the economy’s growth momentum,” he said.

He identified several ways in which economic resilience could help Cyprus withstand the effects of inflation, beginning with the strength of the labour market and the high level of employment.

These conditions support household disposable incomes, allowing private consumption to remain an important driver of economic activity even as rising prices put pressure on purchasing power.

Sound public finances also provide an important safeguard, Patsalides said, because a resilient economy helps maintain a stable flow of tax revenues.

This gives the government the flexibility to introduce targeted support measures for vulnerable groups without placing excessive pressure on public finances.

He also highlighted the importance of the banking sector’s strong capital and liquidity positions, which reinforce financial stability and support banks’ capacity to finance economic activity effectively.

The resilience of the financial system is particularly important when tighter financing conditions threaten to constrain borrowing and investment, both of which are essential for sustaining economic growth.

Another source of strength is the broadening of Cyprus’ productive base, particularly through the development of dynamic sectors such as information and communication technologies.

A more diversified economy is better equipped to absorb external shocks and offset pressures affecting industries that are more exposed to elevated inflation, Patsalides said.

He added that this resilience, together with recent sovereign credit-rating upgrades, was strengthening Cyprus’ attractiveness as a reliable investment destination, supporting continued foreign capital inflows and improving the economy’s growth prospects.

Prudent policies remain essential

Patsalides stressed that economic resilience alone would not eliminate inflationary pressures, making the consistent implementation of prudent economic policies essential.

“In an environment characterised by global challenges, the consistent implementation of prudent economic policies remains the most effective way to shield the economy from the erosion caused by inflation,” he said.

The governor warned that the combination of upside risks to inflation and intensifying threats to the global economy made a comprehensive and disciplined policy approach increasingly important.

For the ECB, the challenge is to prevent the energy shock from becoming embedded in broader price and wage developments without unnecessarily undermining economic activity.

For Cyprus, the priority is to preserve the domestic conditions that have supported growth while limiting the effects of persistent price increases on households, businesses and public finances.

Patsalides’ assessment underlined the importance of maintaining economic stability, protecting purchasing power and strengthening the economy’s capacity to absorb external shocks as uncertainty over energy prices and the wider geopolitical outlook continues.