Fiscal policy in response to inflation should not aim to permanently contain prices through across-the-board tax interventions but should, where necessary, provide targeted and temporary protection to vulnerable groups, the Cyprus Fiscal Council (CFC) said in a presentation on inflation in Cyprus released on Friday.
The presentation, titled ‘Inflation in Cyprus 2025-2026: From the Energy Shock to a Fiscally Prudent Response’, analyses the evolution of inflation through August 2026, the contribution of energy, food and services, as well as fiscal options for temporary and targeted support for vulnerable groups.
According to the CFC, Cyprus saw a ‘sharp reversal’, moving from the lowest inflation rate in the EU in 2025 (0.8%) to the third-highest in the EU in August 2026 (5.2%). It notes that the speed of this shift highlights ‘Cyprus’s unusually high sensitivity to the external energy shock’.
Energy drives the increase
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According to the presentation, energy triggered the rise in inflation, while pressures also broadened to services.
According to the CFC, fuel prices were affected directly, while electricity prices followed with a lag of around two months. Nevertheless, the CFC notes that petrol in Cyprus remains among the cheapest in the EU-27, weakening the case for further tax cuts.
As regards electricity, while the charge for households is close to the EU average, businesses pay the second-highest electricity prices in the EU. ‘For businesses, the high price is a competitiveness issue, not just an inflation issue,’ the CFC stressed.
‘The root of the problem is structural,’ the CFC said, noting that Cyprus imports 88% of its energy, almost entirely petroleum products, with import dependence in 2024 standing at 88%, compared with 57% in the EU. As it notes, energy dependence increases exposure to international disruptions. Every rise in Brent prices feeds through into fuel, electricity generation and transport costs, with the impact being greater on lower-income households and energy-intensive sectors such as hotels and transport.
Furthermore, it added, without interconnection, storage and natural gas, the economy cannot quickly switch to alternative energy sources.
Across-the-board tax cuts are costly
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Across-the-board tax cuts are costly, untargeted, temporarily conceal inflation and tend to become permanent, the CFC stresses, noting that energy costs cannot be permanently addressed through tax interventions. ‘More domestic energy is needed, which can be stored. Priority should be given to storage, grids and the energy upgrading of households, which permanently reduce exposure to oil and ETS costs,’ it said.
According to the CFC, 2026 saw a repeat of ‘the 2022 recipe’, with successive extensions of across-the-board tax cuts affecting excise duty, VAT on electricity and VAT on certain products, with existing measures exceeding pound 200 million.
‘Tax cuts ‘hide’ inflation today and bring it back when they expire,’ the CFC warned, stressing that if tax cuts are used in response to an exceptional shock, they should be temporary, time-limited and reversible.
It also said that a ‘normal’ inflation reference price should be established to distinguish an extreme shock from normal fluctuations. Specifically, it proposed using the average of the previous 36 months at current prices, deflated using the underlying Harmonised Index of Consumer Prices, with a ‘tolerance band’ of ±15%.
‘The deviation from the normal price can determine when, how much and for how long support is provided,’ the CFC noted. As an example, it said that deviations of up to 15% should trigger no intervention, while deviations above 15% lasting less than 12 months should be considered a ‘temporary shock’, with support provided only to vulnerable households. A deviation of more than 15% lasting longer than 12 months could be considered a ‘potential new level’, with support withdrawn gradually over six months.
Under this methodology, according to the CFC, only the period 2022-23 constituted a ‘new level’, while in 2026 all deviations are considered a ‘temporary shock’.
Moreover, according to the CFC, permanently containing prices delays the necessary adjustment of the economy, creates misguided incentives by encouraging greater consumption of imported energy and slowing the shift towards renewables and energy efficiency, increases fiscal costs without a predetermined limit, and turns temporary measures into permanent obligations.
For this reason, it proposed the gradual withdrawal of support, announced in advance with a clear timetable, smoothing the impact only for vulnerable groups and for a limited period, and investing the fiscal space released in storage, grids and the energy upgrading of homes.
In conclusion, the CFC stressed that fiscal policy in response to inflation should not aim to permanently contain prices through across-the-board tax interventions. It should distinguish temporary shocks from permanent changes in relative prices, allow the economy to make the necessary adjustment and, where required, provide targeted and temporary protection to vulnerable groups.