Consequences of geopolitical events to the economy and banking sector have been contained, but the second-round effects are unknown, said Cyprus Central Bank governor Constantinos Herodotou.
He argued that uncertainty in an environment with high inflation and weakened growth prospects might lead to unpredictable new challenges.
The Cyprus economy, he said, continued to record impressive GDP growth despite the outbreak of the Russian-Ukrainian war.
Real GDP growth expanded by about 6% over the first half of 2022, mainly driven by a faster-than-expected recovery in tourism-related activities and growth in information and communication activities.
Weakness in the Cyprus GDP performance could become visible over the second half of 2022 and 2023, primarily owing to the anticipated worsening in the global outlook.
The labour market has exhibited continued resilience, the Governor said.
Over the first half of 2022, the unemployment rate reached 6.7%, well below the 7.5% recorded in 2021.
The resilience of the Cyprus labour market is in line with business views about expecting a relatively small impact from the war.
Regarding developments in the Cyprus banking sector, he said data demonstrates that despite the negative international economic environment, it is proving resilient, exhibiting a solid and healthy financial standing.
As measured by the Common Equity Tier 1 ratio, the solvency position was edging up to 17.5% in Q2 2022, a level higher than the respective European average of 15.2%.
The Liquidity Coverage Ratio, indicating the availability of liquid funds against deposit outflows over a 30-day stressed period, stood at 320% in July, which is more than three times higher than the minimum requirement of 100%, placing Cyprus amongst the most liquid banking sectors in the Union, where the average LCR is 168%.
The non-performing loan ratio has continued its downward trend despite the supply and demand shocks caused by the pandemic and inflationary pressures at 11.2%, with total non-performing loans of €2.9 bln, which is the lowest level observed since 2014.
Herodotou said all banks must remain cautious, prudent and active to confront a challenging period ahead.
He told a London Business School Alumni Cyprus Club event that the pandemic and war in Ukraine had created significant macroeconomic uncertainty in the euro area, associated with high output growth and inflation volatility.
He said GDP is growing at a much slower pace this year than previously expected.
Growth is hampered by soaring energy and commodity costs, low confidence and supply chain disruptions.
Inflation is approaching double digits, and winter with possible energy shortages is on the horizon.
Nevertheless, a recovering tourism industry, decreasing unemployment, and EU funding payments all help to boost activity and limit output loss.
Herodotou said the situation, combined with pre-existing challenges, such as climate change and the new protectionism trend, requires a new approach to Monetary Policy and constitutes a major test for policymakers in the euro area.