The Central Bank of Cyprus has maintained its growth forecast at 2.6 per cent, citing positive developments which have mitigated the fallout from the sanctions imposed on Russia.

The Central Bank of Cyprus (CBC) maintained its forecast for this year’s economic growth rate at 2.6 per cent, indicating that the positive developments in private consumption and investments during the first few months of 2023 offset the impact created by the sanctions imposed on Russia after its invasion of Ukraine.

At the same time, in the June macroeconomic forecasts, the CBC slightly revised downward (-0.2 per cent) the growth rate for 2024, to 2.8 per cent, due to the expected negative impact of the new Russo-Ukrainian sanctions on the business cycle of professional services.

However, the forecast for GDP growth in 2025 remained at 3.1 per cent.

“Private consumption, although projected to slow down, is expected to remain a significant driver of economic growth in the coming years,” emphasised the CBC.

According to the CBC, the expected trajectory of GDP relies mainly on domestic demand for the years 2023-2025 and, to a lesser extent, on net exports in 2023, within the framework of the expansion of foreign companies’ operations that have already established themselves in Cyprus, particularly in the technology sector.

It also depends on the continued rise in tourism revenue, with a recovery to pre-pandemic levels during the first three months of the current year.

Significant contributions are expected primarily from major private investments that are currently underway, as well as projects supporting digital and green development and other reform projects under the National Recovery and Resilience Plan.

Additionally, a minor contribution is anticipated from housing investments due to the government’s interest rate subsidy scheme for new housing loans concluded by the end of 2021.

Inflation forecasts essentially unchanged

According to the CBC, inflation, which is based on the Harmonised Index of Consumer Prices, is projected to significantly slow down in 2023 to 3.3 per cent from 8.1 per cent in 2022.

This is expected as a result of further correction in energy prices, the full stabilisation of disruptions in the supply chain, and the anticipated impact of the unified monetary policy in the eurozone on domestic demand.

Additionally, the contribution from the projected reduced profit margins by companies is noted to contribute to the slowdown in inflation in 2023.

Furthermore, further easing of inflationary pressures is expected in 2024 and 2025, reaching 2.3 per cent and 2 per cent, respectively, due to the stabilisation of energy prices, the consequent deceleration in food prices, and the impact of monetary policy.

Structural inflation, which excludes energy and food, is expected to decline to 3.7 per cent in 2023 compared to 5 per cent in 2022.

It is further projected to decrease to 2.6 per cent and 2.3 per cent in 2024 and 2025, respectively, primarily due to the full stabilization of disruptions in the supply chains in 2023 and in connection with the expected decrease in loan demand resulting from interest rate increases.

The slight upward revision of 0.1 percentage points during the period of 2023-24 compared to the March 2023 forecasts is partially attributed to the incorporation of larger second-round effects from wage increases, which are expected to drive industrial product prices, excluding energy and services, to higher levels compared to the previous forecasts.

A marginal decrease in unemployment is expected this year, with the rate slightly declining to 6.7 per cent of the labour force in 2023 compared to 6.8 per cent in 2022.

As explained by the CBC, this is due to the ongoing tightness observed in the labour market despite the continuing impact of the war in Ukraine, as indicated by the European Commission’s monthly surveys on employment expectations for the next three months.

For the years 2024-2025, a continued declining trend is projected in relation to the expected GDP growth, with unemployment reaching 6.1 per cent in 2024 and 5.6 per cent in 2025, approaching conditions of full employment.

The CBC also noted that the slight upward revision during the period of 2023-25 compared to the March 2023 forecasts (0.1 per cent and 0.2 per cent respectively) reflects the slightly more restrained pace of economic growth, also influenced by sanctions in the professional services sector, mainly in 2024.

Downside risks of divergence

In relation to the probabilities of deviation from the baseline scenario of forecasts, the Central Bank noted that these tend to be slightly downward for GDP and balanced for inflation for the years 2023-2025.

The main downside risks to GDP are related to possible outcomes that are worse than expected for the external environment and lower-than-expected performance of non-tourism service exports due to the sanctions imposed on Russia.

Upside risks include the possibility of higher-than-expected implementation of private sector investment projects, as well as potential better performance in the tourism sector.

Regarding inflation, upside risks primarily arise from possible higher-than-expected energy prices, as well as potentially more persistent effects of time lags.

Specifically, for the years 2024 and 2025, upside risks are associated with possible wage-price spiral feedback, linked to higher long-term inflation expectations.

However, it should be noted that the above-mentioned risks to inflation are offset by stricter-than-expected financing conditions, through the expected negative impact on domestic demand, as well as potential weaker performance in non-tourism service exports due to the sanctions imposed on Russia.