Cyprus GDP growth forecast raised to 3.2 per cent for 2026

Middle East conflict threatens Cyprus growth outlook, economics research centre warns Cyprus’ economy is expected to grow by 3.2 per cent in 2026, up from a previous forecast of 2.7 per cent, as stronger-than-expected economic activity and improving business confidence offset mounting inflationary pressures linked to the conflict in the Middle East, according to a report published by the University of Cyprus’ Economics Research Centre (CypERC) in October. The latest projections point to economic growth moderating from 4.8 per cent in 2025 to 3.2 per cent in 2026 and 3.1 per cent in 2027, with rising prices and tighter monetary conditions expected to weigh on activity over the coming quarters. The revised 2026 forecast is 0.5 percentage points higher than CypERC’s July estimate, while the projection for 2027 remains unchanged. The upward revision reflects stronger-than-expected growth during the second quarter of 2026, alongside favourable developments in the third quarter, including improved economic confidence, low unemployment and continued growth in new housing loans. However, the research centre warned that the outlook remained vulnerable to geopolitical developments, with the Middle East conflict intensifying inflationary pressures and increasing the risk that economic growth could fall short of expectations. Inflation is expected to accelerate sharply, rising from 0.1 per cent in 2025 to 3.1 per cent in 2026, before easing to 2.3 per cent in 2027. The forecasts for 2026 and 2027 are respectively 0.1 and 0.2 percentage points higher than those published in July, reflecting rising international oil prices, strong domestic economic activity and persistently low unemployment. Economic activity remains robust Cyprus’ economy continued to expand faster than the European Union average during the second quarter of 2026, despite mounting inflationary pressures associated with the conflict in the Middle East. Real gross domestic product (GDP) grew by 3.3 per cent year-on-year in the second quarter, accelerating from 3 per cent in the first three months of the year. Real gross value added increased across all economic sectors, with growth accelerating in most industries compared with the previous quarter. Information and communication activities remained among the fastest-growing sectors, although their expansion slowed for the fourth consecutive quarter. Growth in real estate activities and professional services also moderated slightly, extending the slowdown recorded during the first quarter. Consumption growth strengthened further during the second quarter, driven primarily by increased government spending. Private consumption continued to expand above its long-term average, maintaining the pace recorded during the first quarter. Investment also improved, with gross fixed capital formation continuing to grow on the back of increased spending on machinery and equipment and sustained investment in construction. Both exports and imports recorded strong annual growth. However, net exports made a negative contribution to overall GDP growth because imports increased faster than exports. Monthly indicators suggest that economic activity remained robust during the third quarter, although some data pointed to emerging challenges. Retail trade volumes, card purchases and property sale contracts recorded between July and September indicated continued expansion. However, figures for motor vehicle registrations, new company registrations and tourist arrivals provided mixed signals about the strength of economic momentum. The number of registered unemployed people continued to increase year-on-year throughout the third quarter, although the construction sector was a notable exception. Nevertheless, the unemployment rate remained very low in August and well below the EU average, according to Eurostat. The Economic Sentiment Indicator rose above its long-term average during the third quarter, reflecting stronger consumer and business confidence, particularly in services, retail trade and construction. Companies’ employment expectations also strengthened, moving above their historical average. Economic uncertainty declined overall, although uncertainty among businesses in services and retail trade increased in September. Consumers’ and companies’ expectations for future prices remained above their historical averages despite some easing during the quarter. Price expectations among consumers and manufacturing firms rose markedly in September. Inflation and borrowing costs threaten growth Consumer price inflation increased to 3.4 per cent in the third quarter of 2026, up from 2.8 per cent in the second quarter. The acceleration was driven by higher prices for housing, water, electricity, fuels and transport, primarily reflecting rapid increases in international oil prices. Food inflation also continued to add to domestic price pressures, exceeding the overall inflation rate for the third consecutive quarter. CypERC warned that Cyprus’ heavy reliance on imported fossil fuels made its inflation outlook particularly sensitive to international oil prices, which are vulnerable to geopolitical developments. The conflict in the Middle East continued to push up global energy prices during the third quarter, with the effects expected to feed through to the prices of goods and services over the forecast period. Higher food prices are also expected to sustain inflationary pressures, with international food price indices increasing more rapidly during the third quarter than in the first half of 2026. The report said rising prices had already put pressure on real incomes and were expected to restrain economic activity, particularly as labour market conditions normalised. Inflation also increased in the euro area and the United Kingdom during the third quarter, potentially weighing on demand from Cyprus’ main trading partners, particularly for services. Higher interest rates are expected to exert additional pressure on growth, with the effects becoming more pronounced during 2027. Euro area key interest rates increased further in September in response to rising inflation linked to the Middle East conflict, while market interest rates had begun edging upwards in March and stood considerably higher in September 2026 than a year earlier. Domestic interest rates on most loan and deposit categories were also higher in August than in the corresponding month of 2025. CypERC expects tighter financing conditions to restrain both domestic demand and demand from euro area trading partners, with the effects gradually materialising in 2027 and becoming particularly evident after the first quarter. The annual contraction in new corporate lending during January to August 2026 is also expected to weigh on growth prospects. Nevertheless, the research centre said these pressures were being outweighed by the continued dynamism of the domestic economy, supported by recent national accounts data and leading indicators. Continued growth in new housing loans and the banking sector’s strong liquidity and capital position were also supporting the outlook. During the first eight months of 2026, the outstanding stock of loans recorded double-digit growth, while deposits expanded strongly, driven by rising domestic deposits. However, the volume of new loans declined year-on-year over the same period because of contracting business lending, despite strong growth in housing loans. The ratio of non-performing loans to total loans also declined further in June. An exception to the broader increase in domestic borrowing costs was the interest rate on new corporate loans exceeding €1 million, which fell significantly in August to its lowest level in more than three and a half years. Public finances provide support Cyprus’ public finances remained strong during the first eight months of 2026, with the government recording a substantial budget surplus that exceeded the corresponding figure for 2025. Government revenue increased robustly year-on-year, outpacing expenditure growth, while the public debt-to-GDP ratio continued to decline. CypERC said the strong fiscal position was expected to support economic growth by preserving investor confidence amid rising government borrowing costs and helping cushion the effects of cost-of-living pressures. International and domestic stock market indices also recorded further annual gains during the third quarter, while volatility remained relatively subdued. The continued positive performance of equity markets was seen as a sign of economic resilience despite geopolitical tensions and elevated inflation. However, the report cautioned that these favourable effects could prove fragile if financing conditions tightened further and cost-of-living pressures intensified. Growth forecasts remain vulnerable The research centre said downside risks to economic growth continued to outweigh upside risks, with geopolitical tensions and potentially tighter financing conditions posing the main threats. A prolonged conflict or further escalation in the Middle East could increase uncertainty, weaken external demand for services and discourage investment. Further disruption to supply chains could also keep international commodity prices elevated, creating more persistent inflationary pressures and weighing more heavily on economic growth than currently anticipated. Other risks include weaker-than-expected growth among Cyprus’ trading partners, financial market turmoil that could undermine investor confidence, climate-related events and fiscal challenges arising from higher government borrowing costs. Conversely, stronger-than-expected growth could result from resilient demand, a longer tourist season, gradually easing inflationary pressures, government measures to mitigate the cost of living and investments not yet reflected in the available economic data. CypERC’s forecasts remain broadly consistent with those of other institutions, although their projections differ slightly. For 2026, the Central Bank of Cyprus and the International Monetary Fund expect GDP growth of 2.9 per cent, while the Finance Ministry forecasts 3.1 per cent. For 2027, the Central Bank projects growth of 3.1 per cent and the IMF 3.2 per cent, while the Finance Ministry expects growth to moderate to 2.9 per cent. Inflation risks remain tilted upwards CypERC warned that upside risks to inflation continued to dominate, primarily because of the Middle East conflict and the possibility of further increases in international energy and commodity prices. A prolonged period of high commodity prices could trigger second-round inflation effects, reinforcing price pressures, particularly while economic activity remains strong and unemployment low. Other risks include robust wage growth if demand remains resilient, climate-related events that push up food prices and prolonged broad-based fiscal support measures aimed at mitigating the cost of living. The research centre said such fiscal measures could contribute to higher-than-expected inflation, particularly given prevailing labour market conditions. Downside risks to inflation include tighter euro area monetary policy and its cooling effect on demand, particularly if higher borrowing costs substantially reduce private and public spending. Recently introduced fiscal support measures, including cuts to fuel excise duties and reductions in value added tax, could also lower inflation compared with current projections. The gradual transition towards green technologies in Cyprus was identified as another factor that could help reduce inflationary pressures over the forecast period. CypERC based its projections on quarterly national accounts data up to the second quarter of 2026, leading indicators covering the third quarter and monthly data available between July and September. The forecasts incorporated revised national accounts figures published on October 20, 2026.