The new governor of Cyprus’ central bank sees few obstacles to further rate reductions this year — as long as geopolitics don’t get in the way.

“The inflation rate has been declining so monetary policy is being successful, and if the projections of the [European Central Bank] continue to materialize there’s nothing to prevent the Governing Council from reducing interest rates,” Christodoulos Patsalides told POLITICO last week.

The ECB’s Governing Council meets in two weeks and is widely expected to cut its key Deposit Rate for the second time this year, bringing it down to 3.5 percent. While eurozone inflation remains some way off target (and looks likely to overshoot the ECB’s most recent staff forecast), Patsalides said it was always clear the road would be “bumpy.”

“Policymaking is still data-dependent,” he added. “It may be that interest rates are in a declining mode, but it depends on data being in line with ECB projections.”

Patsalides succeeded Constantinos Herodotou as governor of the Central Bank of Cyprus in April. Most recently an economic advisor to Cypriot President Nikos Christodoulides, the 70-year-old banking veteran has inherited a situation that many of his predecessors would have envied: The economy is growing, the country’s credit rating recently received another upgrade, and the EU’s running reports on cleaning up what used to be rampant money-laundering have become steadily more positive (although they still point to numerous shortcomings). In March Cyprus enlisted the help of the F.B.I. to clean up its financial system, another step toward breaking with decades of handling shady Russian money.

For the governor, that leaves geopolitics at the top of the list of concerns. Patsalides stressed that external shocks remain the biggest economic risk.

“Cyprus is a small, open economy and it will be affected negatively if Europe is affected negatively,” Patsalides said, nodding to a tourist industry that is only this year set to reach its pre-pandemic number of arrivals. Most of those tourists come from Europe, over half from the U.K., Germany and Poland.

He chose not to mention the Gaza conflict, which is taking place on the country's doorstep, and which may take on new dimensions if hostilities between Israel and Lebanon-based Hezbollah continue. Then there’s Turkey, which remains an unpredictable and assertive power in the neighborhood. Meanwhile, the prospect of a global trade war between China and the West threatens both regional prosperity and inward investment.

Cyprus’ economic future depends in large measure on its ability to monetize over half a trillion cubic meters of natural gas discovered off its coast over the last 13 years. To do that, however, it needs stability in its backyard, along with a measure of goodwill from neighbors Egypt and Turkey (the former because it needs the gas export infrastructure, the latter because of its historical claims on a large part of the coastal waters involved).

There are also plans for two huge undersea electricity cables that would link Cyprus with Israel, Egypt and south-eastern Europe, and which could slash what are the highest local energy prices in the continent. But these, too, remain hostage to local geopolitics.

The beauty of buffers

The governor didn’t say which of those issues trouble him most. However, it’s not hard to find cause for alarm in the European economy, or in the two wars raging on the continent’s frontiers. Flare-ups in those areas could upend the gains Cyprus has made in recent years. Ratings agency Fitch recently upgraded the country’s long-term credit rating to BBB+, and Cyprus has the largest budget surplus in Europe relative to GDP. Bad loans now account for less than 8 percent of the total in the system, having peaked at nearly 50 percent a decade ago. It has also cultivated a growing tech industry.

“All macro indicators are positive and all banking metrics are positive, but the [issue] is: These will never always be positive, there will be something some time that will take things into negative territory,” Patsalides said. “At the end of [the] day nobody can guess where the next crisis will come from.

“There is always a business cycle,” he added. “No one can accurately predict its tim[ing], evolution and shape. So in banking, capital buffers matter, strong liquidity buffers, strong governance is vital.”

Taken at face value, the balance sheets of Cypriot banks look to be among the strongest in Europe, with core Tier 1 equity — a benchmark measure of financial strength — over 22 percent at the end of the first quarter, while liquidity buffers are likewise well in excess of regulatory demands. That may not guarantee anything — Credit Suisse, after all, met all regulatory requirements until the moment it collapsed — but it's a long way from the crisis of 10 years ago.

Those ratios also reflect, arguably, the enduring suspicions that international investors harbor regarding Cyprus’ institutions. Over the last 20 years, one of Patsalides’ predecessors at the central bank, Christodoulos Christodoulou, has served jail time, while another, Panicos Demetriades, was effectively forced out in 2014 under political pressure from then-President Nicos Anastasiades.

Patsalides, appointed by Anastasiades’ successor and party colleague Nikos Christodoulides, stressed that he would uphold the bank’s independence, noting that the Demetriades incident was “a very long time ago and during a severe crisis.”