Tourism and energy pressures cloud Cyprus economic outlook

The Central Bank of Cyprus (CBC) expects economic growth to slow this year as the Middle East conflict weighs on tourism and investment, while inflation is projected to rise sharply, according to its September forecasts released on Thursday.

The CBC projected GDP growth of 2.9 per cent in 2026, down from 3.8 per cent in 2025, before growth accelerates to 3.1 per cent in both 2027 and 2028.

The forecasts, prepared by the CBC’s Division of Economic Analysis and Monetary Policy, cover GDP, unemployment, inflation and core inflation, while also assessing the main risks to the economic outlook.

The September projections incorporate the economic effects of the ongoing conflict in the Middle East, including higher international oil prices, elevated refining margins and increased geopolitical uncertainty.

The CBC said these factors were expected to have a direct negative effect on the Cyprus economy, particularly through energy prices, tourism and non-residential private investment.

Its baseline scenario assumes that the conflict will continue until the final quarter of 2026, followed by a gradual de-escalation.

Despite the external shocks, the CBC said the economy had continued to show resilience and that domestic demand was expected to support growth throughout the forecast period.

Private consumption is expected to remain positive as households benefit from higher real disposable incomes, although inflationary pressures are continuing.

The labour market is also expected to provide support, while large residential and non-residential investment projects are expected to continue despite the geopolitical uncertainty.

The CBC said the long completion horizons of these projects, together with the expectation that the geopolitical disruption would be temporary, meant they were not expected to be cancelled.

Net exports, however, are expected to make a negative contribution to growth in 2026, mainly because of weaker exports following a decline in tourism revenue during the first half of the year as a result of the Middle East conflict.

Imports are meanwhile expected to accelerate, reflecting strong domestic demand and increased imports of services needed to support related exports.

The picture is expected to improve in 2027 and 2028, when net exports are projected to make a positive contribution to growth, mainly because of a further recovery in tourism.

The CBC has also upgraded its growth forecasts compared with June, raising its 2026 projection by 0.4 percentage points and its 2027 projection by 0.2 percentage points.

For 2026, the revision reflected stronger economic momentum than previously expected despite geopolitical uncertainty, particularly during the second quarter.

The CBC highlighted better-than-expected tourism developments in recent months and strong residential investment as factors behind the revision.

For 2027, the upward revision was linked to an expected strengthening of public investment, particularly through higher defence spending under the European SAFE programme, in which Cypriot companies are expected to participate.

Unemployment falls to historic low

The labour market is expected to remain one of the main sources of resilience, with the CBC forecasting unemployment to fall significantly to 3.8 per cent in 2026.

The rate is then expected to remain at 3.8 per cent in both 2027 and 2028, supported by continued economic growth and persistent tightness in the labour market.

“The historically low unemployment rate demonstrates the expansion of the economy’s productive capacity,” the CBC stated.

The central bank has significantly lowered its unemployment forecasts compared with June, by 0.8 percentage points for 2026 and 0.7 percentage points for both 2027 and 2028.

The revisions reflect a much lower-than-expected unemployment rate during the first half of 2026, together with stronger-than-expected macroeconomic performance over the same period despite geopolitical uncertainty and inflationary pressures.

Inflation expected to reach 3.3 per cent

The most significant deterioration in the outlook concerns inflation, with the Harmonised Index of Consumer Prices forecast to rise to 3.3 per cent in 2026, compared with just 0.8 per cent in 2025.

The CBC attributed the increase primarily to the economic effects of the Middle East conflict, particularly higher energy prices and elevated refining margins.

These pressures are also expected to feed into other components of inflation, including services and food.

Services prices are expected to come under upward pressure because of strong demand in tourism-related sectors, alongside higher energy and other operating costs, with wages making a smaller contribution.

Food prices are also expected to continue rising, mainly because of the indirect effects of higher energy costs.

By contrast, prices for non-energy industrial goods are expected to remain in negative territory during 2026, helping to offset some of the wider inflationary pressures.

The CBC linked this partly to lower import prices from China and the growing use of online purchases, although the depreciation of the euro is expected to exert upward pressure on these prices.

The forecasts also incorporate existing government measures intended to mitigate the impact of higher prices, including VAT reductions on electricity and the extension of reduced fuel excise duties.

Inflation is expected to ease to 2.4 per cent in 2027 and 1.9 per cent in 2028 as energy inflation subsides and the effects of higher production costs gradually work their way through the economy.

Services inflation is also expected to slow, while non-energy industrial goods are projected to continue experiencing deflationary pressures.

The 2028 forecast incorporates the expected implementation of the EU’s expanded Emissions Trading System, known as ETS2, which is expected to have its main impact on transport fuel prices.

Compared with the June forecasts, the CBC raised its inflation projection by 0.1 percentage points for 2026 and by 0.4 percentage points for 2027.

The 2026 revision mainly reflects stronger-than-expected services price pressures, which were partly offset by continued deflationary pressures in non-energy industrial goods and a downward revision to energy inflation resulting from lower oil prices.

The CBC said the impact of lower oil prices was being partly offset by high refining margins.

The larger 2027 revision was primarily attributed to base effects resulting from the lower energy inflation path expected in 2026, with higher refinery and fuel distribution margins also contributing.

Stronger services price developments in 2026 are also expected to carry over into the following year.

Core inflation remains elevated

Core inflation, which excludes energy and food prices, is expected to rise to 2.8 per cent in 2026, compared with 1.9 per cent in 2025.

The CBC attributed the increase mainly to a significant acceleration in services inflation and the indirect impact of higher energy costs on other components of core inflation.

Core inflation is then projected to ease to 2.2 per cent in 2027 and 1.9 per cent in 2028, mainly as services inflation gradually slows.

The 2026 core inflation forecast has been revised upwards by 0.4 percentage points since June, again largely because of stronger-than-expected services price developments.

That impact is partly offset by stronger deflationary pressures in non-energy industrial goods.

There were no changes to the CBC’s core inflation forecasts for 2027 and 2028.

Risks tilted towards weaker growth

The CBC assessed the balance of risks over 2026-2028 as tilted to the downside for GDP and to the upside for inflation.

A renewed escalation of the conflict in Iran could push energy and import prices higher than currently projected, particularly if supply chains are disrupted.

The central bank also identified climate-related risks, including extreme weather events and green taxes, as potential sources of pressure.

Additional risks could arise from stronger-than-expected increases in wages and profit margins.

The CBC also pointed to the possibility of a larger-than-expected economic impact from increases in pension benefits linked to the forthcoming pension reform.

The forecasts broadly envisage Cyprus maintaining relatively strong domestic economic momentum despite the external shocks, but with higher inflation and weaker growth in 2026 before both conditions improve to varying degrees over the following two years.