Middle East conflict takes toll on Cyprus economy with fresh price hikes

The European Commission on Thursday released a report forecasting a slowdown in Cyprus’ economic growth alongside rising inflation, as the Middle East conflict triggers a fresh energy shock.

In its Spring 2026 Economic Forecast, the commission said that Cyprus entered the crisis on a strong footing, supported by solid economic performance in 2025, but warned that the conflict’s impact is expected to be felt in the short term through higher inflation and increased uncertainty.

Headline inflation in Cyprus is projected to rise to 3.6 per cent in 2026, before easing to 2.2 per cent in 2027, reflecting a surge in energy prices followed by gradual normalisation.

Economic growth is expected to moderate, with real GDP forecast to expand by 2.3 per cent in 2026 and 2.7 per cent in 2027, down from 3.8 per cent growth recorded in 2025.

The commission attributed the earlier strong performance to robust private consumption and services exports, particularly in the ICT sector and tourism, alongside rising investment driven by construction activity.

Private consumption is expected to remain the main driver of growth, although it will slow as inflation erodes real disposable incomes and inflows of foreign workers moderate.

At the same time, automatic wage indexation is expected to support household incomes, helping to stabilise spending despite rising prices.

The report also pointed to domestic tourism as a partial buffer, with local demand expected to strengthen in 2026 even as international arrivals remain sensitive to geopolitical developments.

Tourism exports are projected to weaken due to the conflict, although other service exports such as ICT, financial and business services are expected to remain resilient.

The commission said expectations that the conflict may be short-lived could limit precautionary saving, encouraging households to maintain consumption levels.

It added that investment is forecast to slow initially, as rising costs delay decisions, before recovering later in 2026, supported in part by the final year of funding under the Recovery and Resilience Plan.

Despite a projected trade surplus, the current account deficit is expected to widen in 2026, driven by higher oil prices and continued profit repatriation by foreign-owned companies, before narrowing again in 2027.

The labour market is expected to remain strong, with employment projected to grow by 1.3 per cent in 2026 and 1.1 per cent in 2027, while the unemployment rate is forecast to fall to 4.2 per cent, its lowest level in more than a decade.

Real wages are expected to decline in 2026 before accelerating in 2027, as economic growth strengthens and salary adjustments feed through.

Turning to public finances, the commission said Cyprus is expected to maintain fiscal surpluses despite pressures from tax reform and energy support measures.

The general government surplus reached 3.4 per cent of GDP in 2025, and is projected to ease to 2.1 per cent in 2026 and 2.5 per cent in 2027, reflecting the cost of tax reforms and targeted subsidies to offset energy price increases.

The tax reform introduced at the start of 2026 includes reductions in certain company taxes and personal income tax, alongside an increase in the corporate tax rate from 12.5 per cent to 15 per cent.

Government spending has also been affected by measures such as VAT and excise duty reductions on energy, as well as subsidies aimed at protecting households and businesses.

Public investment is expected to benefit from Recovery and Resilience Facility funds in 2026, before declining in 2027, although partly offset by increased defence spending financed through European loans.

The commission highlighted a significant improvement in Cyprus’ debt position, with the debt-to-GDP ratio falling to 55.0 per cent at the end of 2025, dropping below the 60 per cent threshold for the first time since 2009.

This downward trend is expected to continue, with debt projected to decline further to 50.4 per cent in 2026 and 45.5 per cent in 2027, supported by strong nominal GDP growth.

At the European level, the commission warned that the energy shock is weighing on economic activity across the EU, with growth forecasts revised downward.

EU GDP growth is now expected to slow to 1.1 per cent in 2026, before rising to 1.4 per cent in 2027, while euro area growth is forecast at 0.9 per cent and 1.2 per cent respectively.

Inflation across the EU is projected to reach 3.1 per cent in 2026, easing to 2.4 per cent in 2027, with energy prices identified as the main driver.

The commission said that the EU economy remains vulnerable as a net energy importer, with higher energy costs increasing household bills and business expenses while reducing profitability.

It added that consumer confidence has dropped to a 40-month low, reflecting concerns over inflation and employment prospects, although consumption is still expected to underpin growth.

The outlook remains highly uncertain, with the duration of the Middle East conflict seen as the main risk factor.

Furthermore, the commission warned that prolonged disruptions could push energy prices higher than expected, preventing inflation from easing and delaying economic recovery.

Additional risks include supply shortages of key commodities, ongoing trade tensions and weakening labour demand.

At the same time, the commission identified potential upside factors, including faster structural reforms, increased public investment in defence and energy, and productivity gains from artificial intelligence.