Unquestionably, the key current challenge, is to put under control excessive and persistent inflationary dynamics. Monetary policy decisions, however, have to be considered and made within the following context: Monetary policy takes roughly 18 months to affect the real economy as it is channelled through banks, households and firms and consequently impacts their decisions on credit, consumption and investment, respectively. Therefore, monetary policy does not target current inflation but the medium term inflation outlook. At the current juncture that most of inflation is cost push, stemming from energy and food prices, monetary policy attempts to re-align aggregate demand and aggregate supply so as to contain inflationary pressures. So, monetary policy has a more difficult job than when dealing with the typical demand driven inflationary pressures. Therefore, it requires a balanced approach to contain cost-push inflation but avoid having an exacerbated negative effect on output and unemployment. In addition to the balance I mentioned before, monetary policy decisions have to deal with a lot of uncertainty. The risk of a wage-price increases spiral, even though not yet evidenced in the Eurozone, would exacerbate inflationary pressures. If inflation expectations get de-anchored then inflation will persist for much longer. In such a case the pace of interest rate adjustment as well as the final rate level may have to increase. Currently no material de-anchoring has been observed even though some measures indicate inflation expectations to be slightly above 2 per cent in medium term.
The spike in the domestic inflation is mostly attributed to the significant negative impact of the war, as well as the continued consequences of the pandemic. More specifically, the energy component is the largest contributor to the surging trend of domestic headline inflation (with around 45% share of HICP). We expect that our domestic short-term inflation outlook will continue to remain, overall, at very elevated levels, similar to the euro area inflation developments, amid the ongoing significant uncertainty and volatility resulting from the war. More specifically, Cyprus HICP inflation for 2022 has been revised upwards in our most recent projections, now reaching 8,4 percent compared with 7,0 percent in the CBC June 2022 projections. The Cyprus banking sector Let me now give you a brief overview of the banking sector developments in Cyprus. The Banking sector exhibits a healthy financial standing, with solid solvency and liquidity buffers. The solvency position, as measured by the Common Equity Tier 1 ratio amounts to 17.5 percent in the second quarter of 2022, a level higher than the respective European average of 15.2 percent. The Liquidity Coverage Ratio, indicating the availability of liquid funds against deposit outflows over a 30 day stressed period, stood at the level of 320 percent in August 2022 which is more than 3 times higher than the minimum regulatory requirement of 100 percent, placing Cyprus amongst the most liquid banking sectors in the Union, where the average LCR amounts to 165 percent.