Sweden sets interest rate below zero

[STOCKHOLM] The Swedish central bank sent its base interest rate into unprecedented negative territory on Thursday in a radical move to stop stagnant price levels from slumping into deflation.

The bank dropped its zero interest rate to -0.1 per cent and announced it would buy government bonds worth 10 billion kronor (US$1.18 billion) in a bid to bring its inflation rate - which has hovered around zero for two years - closer to its two-per cent target.

"There are signs that underlying inflation (which excludes the food and energy sectors) has bottomed out, but the situation abroad is now more uncertain and this increases the risk that inflation will not rise sufficiently fast," the bank wrote in a statement.

Swedish price levels have been stagnant since 2012 but have yet to drag overall economic activity with them into a state of deflation.

There is a deep concern in many European economies about a deflationary spiral, which central banks find extremely difficult to reverse, where consumers hold off purchases in expectations that prices will fall, triggering a drop in demand that causes cuts in output and jobs and further falls in prices.

With prices across the eurozone sliding the European Central Bank announced in January a bond-buying spree worth 1.14 trillion euros to drive eurozone inflation up.

Sweden's central bank hopes its cut to an all-time low will cheapen the cost of lending in Sweden - already at historically low levels - but some economists cited worries about the country's levels of household debt, which are among the highest in the world.

"This underpins prices on the housing market which relate to household debt levels and the worries about them," Nordea bank's chief economist Annika Winsth told AFP.

"There is a great risk of bad investments. A free lunch will cost you in the long run," she added.

The central bank's bond-buying programme - which targets bonds with maturities of one to five years - serves to encourage investment and lending, and thus spending.

Such programmes also usually lead to a drop in the value of the currency as investors seek better returns elsewhere, and the Swedish krona dropped against the euro and the dollar after Thursday's announcement.

Swedish price levels have yet to take a toll on overall GDP growth - at 1.8 per cent in 2014 and forecast at 2.7 per cent for this year - but the bank does not see inflation picking up until 2016.

Sweden is a member of the European Union but not of the eurozone so it retains control, via its central bank, of monetary policy and interest rates.

The bank changed course in mid-2014 and starting cutting its base interest rate after keeping it at higher levels since 2010.

AFP