Cyprus at risk from inflation

NICOSIA (Reuters) – The Central Bank of Cyprus sent a clear signal of concern yesterday at spiraling inflation fueled by a raft of tax reforms introduced by the government this year. The bank said it would keep interest rates on hold at 5.5 percent for advances and 2.5 percent for deposits because inflationary pressures were building up. «Inflationary pressure is lurking from pay rises in various sectors of the economy, but also from tax reform, which increased disposable incomes,» the Monetary Policy Committee said in a statement. Inflation was running at 3.77 percent in August, from 1.81 percent in August 2001. Further price hikes are expected from January, which could bring inflation next year to 4.0-4.5 percent, the bank said. Authorities introduced a three-point increase in value-added tax to 13 percent in July. In a bid to cushion the effect of that increase, tax authorities raised earners’ tax-free threshold, leaving them with more disposable income. VAT is expected to rise another two points to the EU minimum of 15 percent in January. The growth rate of the country’s gross domestic product (GDP) has been stunted this year from a slump in tourism, the island’s main money earner. The economy is expected to expand by 2.5-3.0 percent in real terms, compared to 4.0 percent in 2001. Tourism, which contributes 22 percent to the GDP total, was down 12.3 percent year-on-year in July, while unemployment was relatively higher than 2001, it said. Reflecting the slowdown, new commercial bank credit for the first eight months of the year was little over half that extended for the same period of 2001. Credit grew by 8.4 percent by August, compared to 15.3 percent in 2001. Liquidity in the banking system was an additional inflationary risk, but it was counterbalanced by low demand, the bank said.