Cyprus inflation could offset ECB rate cut benefits

The European Central Bank (ECB) cut its three key interest rates by 25 basis points on Thursday, marking the first reduction after nearly two years of increases or stasis. Effective 12 June 2024, the interest rate on the main refinancing operations will drop to 4.25%, while the marginal lending facility and deposit facility rates will fall to 4.50% and 3.75%, respectively.

The ECB's decision is poised to benefit the economy by lowering borrowing costs for businesses and households, potentially boosting consumption. Public and private debt levels are expected to decrease slightly, and new borrowing will become marginally cheaper. The positive effects could be amplified if the ECB continues to reduce rates in future monetary policy sessions.

Despite recent progress, domestic price pressures remain robust due to rising wage growth. Inflation is likely to stay above target through much of 2025. ECB experts forecast overall inflation to average 2.5% in 2024, 2.2% in 2025, and 1.9% in 2026. Excluding energy and food, inflation is expected to average 2.8% in 2024, 2.2% in 2025, and 2.0% in 2026.

However, challenges persist. In May 2024, Cyprus experienced a significant inflation spike, with a 2.7% increase year-on-year. The Cyprus Statistical Service reported that the Consumer Price Index (CPI) rose to 117.84 points in May, up from 117.09 points in April. This marks a notable rise since the ECB's last rate hike in November 2023.

Economist Dr. K. Alexandros Apostolides expressed concerns over the ECB's rate cut, noting that "Cyprus has the second highest rate of inflation growth, and lower interest rates put the country in a precarious position." Apostolides highlighted that the government's efforts to curb inflation may not have been sufficient, complicating the economic outlook. He recalled that Cyprus had previously achieved significant inflation reduction compared to other European countries, suggesting that a rate cut during that period would have been advantageous.

"The government's decisions to increase ATA and provide broad support measures like fuel subsidies have created economic discomfort," Apostolides said. "While Cypriot consumers may see some relief on their loans, Cyprus's high inflation growth rate means that interest rate cuts will not be as beneficial."

Apostolides stressed the need for fiscal discipline and strategic measures, particularly for a service-based economy like Cyprus. "We need inflation growth rates below the European average. For instance, accountants in Cyprus should be cheaper than those in Luxembourg to ensure strong economic growth."

The ECB's rate cuts are a step towards easing economic pressures, but as Cyprus's situation illustrates, the path to stability is complex and requires careful policy management.

[Summary of Panayiotis Rougalas' original story in Greek published in Kathimerini's Cyprus edition]