Fiscal policy regarding inflation should not aim to permanently keep prices in check through across-the-board tax measures, but, only where necessary, it should provide targeted and temporary protection for vulnerable groups, according to a presentation on inflation in Cyprus by the Cyprus Fiscal Council (CFC).
The presentation, titled “Inflation in Cyprus 2025–2026: From the Energy Shock to a Fiscal-Prudent Response,” analyzes inflation trends through August 2026, the contribution of energy, food, and services, as well as fiscal policy options for temporary and targeted support for vulnerable groups.
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According to the ESC, Cyprus experienced a “sharp reversal,” as it went from having the lowest inflation rate in the EU in 2025 (0.8%), it rose to the third-highest in the EU in August 2026 (5.2%). As noted, the speed of this shift indicates “Cyprus’s unusually high sensitivity to external energy shocks.”
Specifically, the presentation notes that in 2025, average inflation in Cyprus was 0.8%, the lowest in the EU, with rates close to 0% from July through December. The rise in inflation in Cyprus began in March 2026 (1.5%), coinciding with the crisis in Iran and the Strait of Hormuz, and reached 5.2% in August. As noted, Cyprus is now 2 percentage points above the eurozone average, whereas a year ago it was 2 percentage points below, with forecasts for 2026 ranging from 3.3% by the Central Bank of Cyprus to 3.6% by the European Commission. The CBC forecasts that inflation will hover around 2.4% in 2027.
Energy Drives the Rise
According to the presentation, energy prices triggered the rise in inflation, while inflationary pressures also spread to the services sector.
Specifically, energy prices rose from −8.8% in February to +15.5% in August 2026. At the same time, services rose from 4.2% to 7.4%, restaurants and lodging by +13.3%, transportation by +9.8%, and food from 2.4% to 3.2%. On the other hand, industrial goods continue to experience deflation (−2.3%).
According to the CBA, fuel prices were directly affected, while electricity prices followed with a lag of about two months. Nevertheless, the CBA notes that gasoline in Cyprus remains among the cheapest in the EU-27, a fact that weakens the case for further tax cuts.
On the other hand, regarding electricity, while rates for households are close to the EU average, businesses pay the second-highest electricity rates in the EU. “For businesses, high prices are a matter of competitiveness, not just inflation,” the DSK emphasizes.
“The root of the problem is structural,” notes the CCI, pointing out that Cyprus imports 88% of its energy, almost entirely in the form of petroleum products, with import dependence in 2024 projected to reach 88% compared to 57% in the EU. As noted, petroleum products account for 86% of available energy (EU: 38%) and 96% of energy imports. Furthermore, it is noted that the electricity grid is isolated and 76% of electricity generation comes from oil.
As noted, energy dependence increases exposure to international disruptions. Every rise in the price of Brent crude is passed on to the cost of fuel, electricity generation, and transportation, with the burden falling heaviest on low-income households and energy-intensive sectors, such as hotels and transportation.
Furthermore, it adds, without interconnections, storage, and natural gas, the economy cannot quickly shift to other sources.
Regarding renewable energy, the DSK notes that it is on the rise, but Cyprus remains among the lowest-ranking countries in the EU in terms of electricity from renewable sources, with a projected share of 21.5% in 2025 (up from 9.9% in 2015), compared to 26.2% in the EU. The share of renewable energy in electricity generation in 2025 was 27.5%, the fifth-lowest figure in the EU (EU: 49.9%).
However, the CEC points out that the obstacle is not RES generation but its integration, since the grid rejects cheap solar energy due to a lack of storage and electrical interconnections.
Regarding storage, the DSK refers to the batteries that the DSK and the AHK announced they would install, and notes that there is a delay of approximately one year compared to the original plan.
Regarding the electrical interconnection (GSI), it states that the project is delayed, with no official new timeline in place. “The system remains isolated, with no backup from the market,” it adds.
Furthermore, it notes that the arrival of natural gas (Vasilikos) is also delayed, with the initial contract having expired and no official date set for the first gas delivery.
Across-the-board tax cuts are costly
Across-the-board tax cuts are costly, not targeted, temporarily mask inflation, and tend to become permanent, the DSK emphasizes, noting that energy costs cannot be permanently resolved through tax measures. “We need more domestically produced energy that can be stored. Priority should be given to storage, grid infrastructure, and energy upgrades for households, which permanently reduce exposure to oil and ETS costs,” it states.
According to the DSK, 2026 saw a repeat of “the 2022 formula” with across-the-board tax cuts and successive extensions of the excise tax, the VAT on electricity, and the VAT on specific products, with the existing measures totaling over €200 million.
“Tax cuts ‘mask’ inflation today and bring it back when they expire,” warns the DSK, noting that if tax cuts are used in response to an extraordinary shock, they must be temporary, limited in scope, and reversible.
Furthermore, it states that a “normal” inflation reference value must be established to distinguish extreme shocks from normal fluctuations. Specifically, it proposes as a reference value the average of the last 36 months at current prices, deflated by the underlying Harmonized Index of Consumer Prices and with a “tolerance band” of ±15%.
As alternative benchmarks, it proposes the cost of fuel imports (Brent in € + average margin + applicable taxes) or the EU average before taxes.
“The deviation from the normal price can determine when, how much, and for how long support is provided,” suggests the DSK, noting, as an example, that for a deviation of up to 15%, no intervention should be taken, while a deviation of more than 15% lasting less than 12 months should be considered a “temporary shock,” with support provided only to vulnerable households. A deviation exceeding 15% for more than 12 months may be considered a “potential new baseline,” and support should be phased out linearly over 6 months.
Using this method, according to the DSK, the only “new level” was the 2022–23 period, while in 2026 all deviations are considered “temporary shocks.”
Furthermore, according to the DSK, permanently keeping prices low delays the necessary adjustment of the economy, creates misguided incentives leading to increased consumption of imported energy and a slower transition to renewable energy and energy conservation, increases fiscal costs without a predetermined limit, and turns temporary measures into permanent obligations.
For this reason, it proposes the gradual and pre-announced withdrawal of support, with a clear timeline, with relief provided only for vulnerable groups and for a limited time, and for the fiscal space thus freed up to be invested in energy storage, grid infrastructure, and energy upgrades for residential buildings.
In conclusion, the DSK emphasizes that fiscal policy regarding inflation should not aim to permanently suppress prices through across-the-board tax measures. It must distinguish between temporary shocks from permanent changes in relative prices, allow for the necessary adjustment of the economy, and, where necessary, provide targeted and temporary protection for vulnerable groups.
Source: KYPE
