Sweden's flag blowing in the wind against a clear blue sky.

Sweden’s central bank cut interest rates to zero – a record low – as it stepped up its increasingly desperate fight against deflation.

The Riksbank cut its repo rate by more than markets were expecting as it moved from 0.25 per cent to zero, reversing a series of rises that had brought interest rates up to 2 per cent at the end of 2011.

The Swedish krona hit a fresh four-year low after the rate cut, falling by 0.7 per cent to 7.354 to the US dollar.

The world’s oldest central bank is in the global spotlight as it seeks to combat deflation. Sweden has experienced falling prices in 16 of the past 24 months.

Stefan Ingves, the Riksbank’s governor, has come under pressure from the likes of economist Paul Krugman for lifting rates in 2010 and 2011 to counter what Sweden’s central bank saw as a risk of a housing bubble. Mr Krugman called that policy “sadomonetarism”, as unemployment remained above the historical average and inflation was weakening.

The Riksbank justified Tuesday’s cut by citing the weak outlook for prices with both core inflation – its preferred measure – and long-term inflation expectations below its target of 2 per cent.

“The Swedish economy is relatively strong and economic activity is continuing to improve. But inflation is too low. The executive board of the Riksbank has therefore decided that monetary policy needs to be even more expansionary for inflation to rise towards the target of 2 per cent,” it added.

The central bank said rates needed to stay low until inflation “has clearly picked up”.

It added that slow increases in interest rates would now be likely to begin in the middle of 2016, a delay from the previous guidance that they would start at the end of next year. The Riksbank said rates should reach 1.75 per cent by the end of 2017.

“It’s a problem for the Riksbank’s credibility that they have to make these adjustments,” said Robert Bergqvist, chief economist at SEB, the Swedish bank. “But they are not alone. We can see many other central banks and countries that are facing similar challenges.”

Swedish inflation

Some analysts have suggested the Riksbank’s next move could be to cut interest rates to below zero or launch asset purchases along the lines of the quantitative easing policy used in the US and UK. But economists at Nordea, the pan-Nordic bank, said it did not expect unconventional measures as the Swedish economy was working well.

“If unconventional measures were to become relevant, in contrast to our expectations, a floor for the krona exchange rate against the euro is the most likely choice,” Nordea said.

The Riksbank itself said it did not envisage using what it called “complementary monetary policy measures” alongside zero interest rates. But it added: “If conditions were to change the Riksbank has the same possibilities as other central banks to take further measures to increase the monetary policy stimulus.”

Swedish Krona

Mr Bergqvist said the situation was not yet critical as Sweden’s economy continued to record growth and inflation expectations remained positive, albeit below the Riksbank’s target. But he added that the Swedish central bank has shown that it lacks understanding of inflationary dynamics.

“The Riksbank has been too slow to adjust its economic models and maybe too backwards looking. It seems it has not understood the impact of globalisation on inflation,” Mr Bergqvist said.

The Riksbank continued to fret about the impact of low interest rates on a strong housing market although it has conceded that other regulators should fight against household indebtedness using so-called macroprudential measures such as stricter borrowing limits. The ratio of household debt to income stands at 174 per cent.

“With this low repo rate for a long period of time, it becomes increasingly urgent for other policy areas to manage the risks associated with household indebtedness and developments on the housing market,” the central bank added.

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