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.

Industrial producer prices in Cyprus rose by 6.2 per cent year-on-year in September 2026, driven mainly by higher electricity prices, according to figures released by the Cyprus Statistical Service (Cystat) on Friday.

The increase came as the Producer Price Index for Industry reached 130.5 points in September, using 2021 as the base year, marking a 2.3 per cent rise compared with August.

For the first nine months of 2026, industrial producer prices increased by 2.1 per cent compared with the corresponding period of 2025, indicating that price pressures across the industrial sector continued to build.

The strongest annual increase was recorded in electricity supply, where producer prices rose by 21.1 per cent compared with September 2025.

Water supply and materials recovery followed with an increase of 10.3 per cent, while manufacturing prices rose by 2.4 per cent and prices in mining and quarrying increased by 0.8 per cent.

The monthly figures also highlighted the influence of electricity costs, with electricity supply prices climbing by 10.5 per cent between August and September 2026.

Over the same period, prices in water supply and materials recovery increased by 1.7 per cent, while manufacturing recorded a more modest rise of 0.2 per cent.

Mining and quarrying prices remained unchanged compared with the previous month.

The figures suggest that electricity was the main contributor to the overall monthly increase, while annual price growth was evident across all four main industrial sectors.

Within manufacturing, several industries recorded particularly pronounced annual increases in September.

The largest rise was in the manufacture of computer, electronic and optical products, where producer prices increased by 13 per cent compared with the same month in 2025.

This was followed by the manufacture of basic metals and fabricated metal products, which recorded an increase of 5.6 per cent.

Prices in furniture manufacturing and repair and installation of machinery rose by 5.2 per cent.

The wood industry, including the manufacture of products made from wood and cork, excluding furniture, recorded an annual increase of 4.5 per cent.

Meanwhile, the manufacture of machinery and equipment, motor vehicles and other transport equipment saw prices rise by 2.9 per cent.

The increases across manufacturing categories indicate that price pressures were not confined to energy-related activities, but were also evident in a range of industrial production and equipment-related sectors.

The overall Producer Price Index measures changes in prices received by domestic producers for their industrial output and provides an indication of cost and pricing developments across the sector.

Cyprus household debt stood at €20 billion, equivalent to 53 per cent of gross domestic product (GDP), at the end of June 2026, while debt among non-financial companies reached €41.7 billion, or 111 per cent of GDP, according to figures released on Friday by the Central Bank of Cyprus (CBC).

The figures show that household indebtedness has fallen by 65 per cent since December 2016, while the debt-to-GDP ratio of non-financial companies has declined by 95 per cent over the same period, pointing to a substantial reduction in borrowing across both sectors.

Despite the improvements, corporate debt remained considerably higher than household debt, with non-financial companies carrying liabilities equivalent to more than the value of the country’s annual economic output.

The CBC reported that household financial assets totalled €67.1 billion at the end of June 2026, considerably exceeding their outstanding debt.

Cash, deposits and loans accounted for 54 per cent of these assets, while shares represented 25 per cent, other financial assets 17 per cent and debt securities the remaining 4 per cent.

The figures provide an overview of the financial position of households, businesses and institutional investors, including insurance companies, investment funds and pension funds.

For non-financial companies, financial assets reached €77.9 billion at the end of June, with shares accounting for the largest portion at 37 per cent.

Other financial assets represented 33 per cent of the total, while cash and deposits accounted for 24 per cent, loans for 5 per cent and debt securities for 0.6 per cent.

Meanwhile, the sector’s outstanding debt amounted to €41.7 billion, with its debt-to-GDP ratio standing at 111 per cent, representing a marginal decrease compared with the previous quarter.

The CBC’s comparison with December 2016 showed that the debt-to-GDP ratio of non-financial companies had fallen by 95 per cent, indicating a substantial improvement in the sector’s indebtedness over the period.

The central bank also provided a breakdown of financial assets held by insurance companies, investment funds and pension funds, highlighting the different ways in which these institutional investors allocate their holdings.

Insurance companies held financial assets worth €6.5 billion at the end of June 2026, with almost half of their portfolios invested in shares.

Equities accounted for 47 per cent of their financial assets, followed by debt securities at 26 per cent and other financial assets at 20 per cent.

Cash and deposits represented 6 per cent of the total, while loans accounted for the remaining 2 per cent.

Investment funds held €7.9 billion in financial assets, with their portfolios heavily concentrated in shares, which represented 80 per cent of their total holdings.

Loans and debt securities together accounted for 13 per cent, while cash and deposits represented 4 per cent and other financial assets the remaining 3 per cent.

Pension funds, meanwhile, held €5.1 billion in financial investments, with shares accounting for 59 per cent of their portfolios.

Other financial assets represented 9 per cent, debt securities 6 per cent, while cash and deposits accounted for 12 per cent and loans for 13 per cent.

The figures underline the significant role played by equities in the investment portfolios of insurance companies, investment funds and pension funds, although the composition of their holdings varies considerably.

Cyprus’ unemployment rate remained at 4 per cent in September 2026, unchanged from August and below the 4.2 per cent recorded a year earlier, while youth unemployment stayed at 11.3 per cent, according to figures published by Eurostat on Friday.

The number of unemployed people in Cyprus stood at approximately 21,000 in September, down from around 22,000 in September 2025, as the labour market continued to perform better than the European Union average.

The figures also showed that youth unemployment in Cyprus declined over the past year, with the number of unemployed people aged under 25 falling from approximately 4,000 in September 2025 to 3,000 in June 2026, where it remained through September.

Across the EU, however, unemployment increased over the year, with the overall rate reaching 6.2 per cent in September, compared with 6 per cent in the same month of 2025.

The euro area unemployment rate stood at 6.5 per cent, unchanged from August but higher than the 6.3 per cent recorded a year earlier.

Eurostat, the statistical office of the European Union, estimated that 13.773 million people were unemployed across the EU in September, including 11.555 million in the euro area.

Compared with August, the number of unemployed people increased by 105,000 across the EU and by 122,000 in the euro area.

On an annual basis, unemployment rose by 471,000 across the EU and by 420,000 in the euro area.

Cyprus unemployment remains below EU average

Cyprus’ unemployment rate declined from 4.2 per cent in September 2025 to 3.8 per cent in June 2026, before edging up to 3.9 per cent in July and reaching 4 per cent in August, where it remained in September.

The number of unemployed people followed a similar pattern, falling from approximately 22,000 in September 2025 to 21,000 in June and July 2026.

The figure increased to around 22,000 in August before returning to approximately 21,000 in September.

The latest figures place Cyprus’ unemployment rate 2.2 percentage points below the EU average and 2.5 percentage points below the euro area rate.

While the EU and euro area have experienced an increase in unemployment over the past year, Cyprus’ rate has declined, indicating comparatively favourable labour market conditions.

Youth unemployment remains lower in Cyprus

The unemployment rate among people aged under 25 in Cyprus stood at 11.3 per cent in September 2026, unchanged from July and August and below the 12.9 per cent recorded in September 2025.

The rate had fallen to 11.8 per cent by June 2026 before declining further to 11.3 per cent in July.

The number of unemployed young people also decreased over the year, from approximately 4,000 in September 2025 to 3,000 in June 2026, remaining at that level through September.

The figures compare favourably with the wider European picture, where youth unemployment continued to rise.

Across the EU, the youth unemployment rate reached 15.5 per cent in September, up from 15.4 per cent in August.

In the euro area, the rate increased to 15.4 per cent from 15.1 per cent in the previous month.

Eurostat estimated that 3.022 million people aged under 25 were unemployed across the EU in September, including 2.469 million in the euro area.

Compared with August, youth unemployment increased by 44,000 across the EU and by 69,000 in the euro area.

Compared with September 2025, the number of unemployed young people rose by 45,000 in the EU and by 80,000 in the euro area.

Unemployment among women and men

The unemployment rate for men in Cyprus stood at 3.7 per cent in September 2026, unchanged from July and August, after declining from 4 per cent in September 2025 to 3.6 per cent in June 2026.

Among women, the rate reached 4.3 per cent in September, down from 4.4 per cent a year earlier.

Female unemployment had fallen to 4.1 per cent in June 2026 before increasing to 4.2 per cent in July and 4.4 per cent in August, then edging down in September.

The figures show that the unemployment rate for women remained higher than that for men in Cyprus, although the difference narrowed slightly in September.

Across the EU, the unemployment rate for women stood at 6.4 per cent in September, while the rate for men was 6 per cent, with both unchanged from the previous month.

In the euro area, female unemployment remained at 6.7 per cent, while the male rate increased to 6.4 per cent from 6.3 per cent in August.

European unemployment rises over the year

The wider European figures showed a gradual increase in unemployment compared with September 2025, despite rates remaining stable between August and September 2026.

In the euro area, the unemployment rate rose from 6.3 per cent in September 2025 to 6.4 per cent in June 2026, before reaching 6.5 per cent in July and remaining at that level through September.

The number of unemployed people in the euro area increased from 11.135 million in September 2025 to 11.555 million in September 2026.

Across the EU, the unemployment rate increased from 6 per cent in September 2025 to 6.2 per cent in June 2026, remaining at 6.2 per cent through September.

The total number of unemployed people across the bloc rose from 13.302 million to 13.773 million over the same period.

The latest figures therefore highlight a contrast between Cyprus, where overall unemployment and youth joblessness remained below their levels a year earlier, and the wider EU, where both the number of unemployed people and the overall rate increased.

Cyprus’ tax-to-GDP ratio rose to 36.3 per cent in 2025 from 36 per cent a year earlier, according to Eurostat, as tax and social contribution revenues increased across most European Union member states.

The figures show that Cyprus remained below the EU average, where the overall tax-to-GDP ratio climbed to 40.7 per cent in 2025 from 40.2 per cent in 2024.

Across the euro area, the ratio increased more sharply, reaching 41.3 per cent, compared with 40.7 per cent in the previous year.

The tax-to-GDP ratio measures the combined revenue governments collect from taxes and net social contributions as a share of gross domestic product (GDP), providing an indication of the relative size of tax revenues in an economy.

In absolute terms, EU revenue from taxes and social contributions increased by €401 billion in 2025 to reach €7.68 trillion, compared with the previous year, Eurostat reported.

Despite the overall increase, significant differences remained between member states, reflecting variations in national tax systems, social contribution arrangements and the size of government revenue relative to economic output.

France recorded the highest tax-to-GDP ratio in the EU at 46 per cent, followed by Belgium at 44.7 per cent, Denmark at 44.3 per cent and Austria at 43.9 per cent.

At the other end of the scale, Ireland registered the lowest ratio at 22.7 per cent, followed by Romania at 29.3 per cent, Malta at 30.3 per cent and Bulgaria at 30.6 per cent.

Cyprus’ ratio of 36.3 per cent placed it below the EU and euro area averages, although its increase from 2024 indicated that tax and social contribution revenues had risen relative to the size of the economy.

Tax ratios rise across most EU countries

Eurostat said the tax-to-GDP ratio increased in 19 EU member states in 2025 compared with the previous year.

Germany recorded the largest increase, with its ratio rising from 40.3 per cent in 2024 to 41.4 per cent in 2025.

Malta followed, with an increase from 29.3 per cent to 30.3 per cent, while Spain’s ratio climbed from 37.2 per cent to 38.1 per cent.

In contrast, the ratio declined in eight member states, with the largest decreases recorded in Sweden and Latvia.

Sweden’s tax-to-GDP ratio fell from 41.8 per cent in 2024 to 41.2 per cent in 2025, while Latvia’s declined from 34.9 per cent to 34.2 per cent.

The figures underline the differing trends in government revenue across the bloc, with the overall EU and euro area ratios increasing despite reductions in several individual countries.

For Cyprus, the rise from 36 per cent to 36.3 per cent represented a comparatively modest increase, leaving the country’s ratio below the European averages in 2025.

Cyprus’ industrial production fell by 1.3 per cent year-on-year in August 2026, with a decline in manufacturing outweighing increases in mining, water supply and electricity, according to the Cyprus Statistical Service (Cystat).

The Industrial Production Index reached 90.9 points in August, using 2021 as the base year with a value of 100, marking a decrease compared with August 2025.

Despite the monthly annual decline, industrial production increased by 1.2 per cent during the first eight months of 2026 compared with the corresponding period of the previous year.

The manufacturing sector recorded a 2.5 per cent annual decrease in August.

By contrast, mining and quarrying production rose by 11 per cent, while water supply and materials recovery increased by 5.7 per cent.

Electricity supply recorded a marginal increase of 0.1 per cent over the same period.

Within manufacturing, the strongest annual increases in August were recorded in the production of rubber and plastic products, which rose by 7.1 per cent, and wood and cork products, excluding furniture, which increased by 6.4 per cent.

The sharpest decline was recorded in the manufacture of machinery and equipment, motor vehicles and other transport equipment, where production fell by 12.8 per cent compared with August 2025.

Manufacturing of refined petroleum products, chemicals and chemical products, and pharmaceutical products and preparations declined by 7.1 per cent.

Production of other non-metallic mineral products fell by 4.8 per cent year-on-year.

Looking at the January to August 2026 period, the strongest increases compared with the same period in 2025 were recorded in water collection, treatment and supply, which rose by 11.5 per cent.

Manufacturing of basic metals and fabricated metal products increased by 5.5 per cent, while production of wood and cork products, excluding furniture, rose by 5 per cent.

The largest cumulative declines were recorded in materials recovery, which fell by 6.7 per cent, and the manufacture of machinery and equipment, motor vehicles and other transport equipment, which decreased by 6.2 per cent.