Central Bank sees strong private demand supporting Cyprus economy

The Central Bank of Cyprus (CBC) on Friday made a slight downward revision to the country’s growth forecast for 2025, adjusting it to 3.1 per cent from 3.2 per cent in March.

At the same time, a significant reduction in the inflation estimate was also recorded, now set at 1.5 per cent from the previous 2.1 per cent.

The CBC said in its announcement that the projections were completed before the recent conflicts between Israel and Iran, and thus, any related economic impacts are not included.

The Gross Domestic Product (GDP) growth for 2025 is expected to reach 3.1 per cent, compared to 3.4 per cent in 2024, while for 2026 and 2027, the GDP is anticipated to expand by 3 per cent annually.

The projected GDP trajectory is mainly attributed to the expected further increase in domestic demand throughout the forecast period and, to a lesser extent, to external demand during 2026-27, which is negatively affected by the exceptional uncertainty in the global geopolitical and trade environment.

Domestic demand is anticipated to be bolstered by the rise in private consumption driven by increased real disposable income of households and the continued resilience of the labour market.

Private consumption, although expected to moderate in its growth rate in the coming years, is projected to remain a significant driver of economic growth.

Additionally, substantial support to domestic demand is expected from ongoing large non-residential private investments, infrastructure projects to support digital and green development, and other reform projects under the Recovery and Resilience Plan.

Any remaining negative impact on domestic demand from previous European Central Bank (ECB) key interest rate hikes is expected to be fully eliminated by the end of 2025.

Despite ongoing changes in US tariff policies and the resulting uncertainty in global trade, no significant negative impact on investments or private consumption is anticipated due to Cyprus’ limited goods trade with the US.

“Any economic impact will be indirect through the deterioration of economic sentiment and Cyprus’ dependence on external demand for services provision” the central bank stated.

Regarding net exports, substantial contributions are expected from the technology sector and increased related service exports for intellectual property usage.

To a lesser extent, net exports are also expected to benefit from the growth in financial and professional services turnover, partly due to the diversification of export markets, as well as from the shipping sector, which continues to positively contribute to growth.

Furthermore, net exports are supported by the positive trajectory of tourism, with a notable increase in Israeli tourist inflows during the early months of 2025, despite the ongoing Middle East conflict, and due to the continued diversification of the tourism product towards high-spending markets.

However, the recent closure of Middle Eastern airspace is expected to adversely affect tourism sector prospects.

Compared to the March 2025 forecasts, a minor downward revision in GDP growth by 0.1 percentage points has been made for each year during 2025-26, mainly due to the anticipated weaker external demand amid increased uncertainty.

“The labour market continues to support the Cypriot economy and demonstrates significant resilience” the central bank said.

Moreover, unemployment is expected to decrease to 4.7 per cent of the labour force in 2025, from 4.9 per cent in 2024.

This aligns with the positive trends recorded in the European Commission’s Economic Sentiment Surveys regarding employment expectations for the next three months and the continued decline in registered unemployed.

In conjunction with expected GDP growth, unemployment is projected to stabilise around 4.7 per cent during 2026-27, approaching full employment conditions.

Compared to the March 2025 forecasts, there is a slight upward revision of 0.1 percentage points in the unemployment rate for 2026 and 2027, due to the small downward revision in GDP growth resulting from the weaker external environment.

Inflation, based on the Harmonised Index of Consumer Prices (HICP), is projected to decline to 1.5 per cent in 2025 from 2.3 per cent in 2024, rising to 2 per cent in 2026 and 2.4 per cent in 2027.

The significant drop in inflation for 2025 is mainly due to downward pressures on energy prices, which were in place before the hostilities between Iran and Israel.

It is also partly due to the effects of monetary policy, which continues to suppress demand, albeit with a significantly diminished impact this year.

Additionally, wage-driven inflationary pressures are expected to moderate due to anticipated slower wage increases during 2025-27 compared to 2024.

The rise in inflation in 2026 and 2027 is primarily attributed to expected higher energy and food prices, and the ongoing deceleration in service prices.

The slowing of service prices is expected due to continued deceleration in domestic demand and reduced wage pressures.

The inflation impact of energy and overall inflation will also reflect the introduction of the carbon tax related to the expanded EU Emissions Trading System (ETS2) from 2027.

Compared to the March 2025 projections, the downward revision of inflation by 0.6 and 0.1 percentage points for 2025 and 2026 respectively is mainly due to the substantial downward revision in energy prices.

This results from projected international oil price developments as well as from the recent government electricity cost relief measure (April 2025 to March 2026), partially offset by the expected carbon tax introduction on fuels for road transport and building heating in the second half of 2025.

The downward revision of inflation is also due to the decline in industrial product prices excluding energy, based on recent data.

For 2027, the upward revision by 0.3 percentage points is due to a positive base effect on energy prices and a slightly stronger than expected impact of the full replacement of the green ETS2 tax.

Core inflation, excluding energy and food, is expected to decline further compared to 2024 (2.6 per cent), reaching 2.1 per cent in 2025 and 1.9 per cent for 2026 and 2027.

The path of core inflation is mainly influenced by restrained increases in industrial product prices excluding energy and the appreciation of the euro against the dollar, which lowers import prices.

Service prices are expected to decelerate during 2025-2027 compared to 2024, but remain above 2 per cent due to the expected positive external demand, particularly in tourism services, and the continued labour market resilience.

Compared to March 2025 forecasts, the slight downward revision of core inflation by 0.1 percentage points for each year during 2025-27 is mainly due to the lower industrial product inflation excluding energy.

The central bank also highlighted that the risks of deviation from the baseline scenario for GDP projections for 2025-27 tend overall to be on the downside.

Downside risks are mainly related to higher energy prices due to potential escalation of Israel-Iran conflicts and negative impacts on tourism flows.

They are also linked to the expected course of external demand, which is indirectly affected by ongoing uncertainty in global trade policy.

On the other hand, upside risks are associated with the positive impact of tax reform on private consumption from 2026, higher wages than expected in the baseline scenario, due to the current environment nearing full employment, and potentially higher foreign demand for services due to further diversification of export markets.