Sweden's Riksbank cuts interest rates to 0.25%

Sweden's central bank has cut interest rates by 0.5 basis points as it tries to head off the threat of deflation amid intense international scrutiny of its monetary policy.

The Riksbank was widely expected to reduce rates after five consecutive months this year without positive inflation, but the size of Thursday's cut - to 0.25 per cent - took markets by surprise and led to a sharp fall in the Swedish krona.

The currency fell 2 per cent against both the US dollar and euro, while the Norwegian krone hit a 2-year low amid expectations Sweden's move would force its Nordic neighbour bank to follow suit. "Very dovish, not expected," Erica Blomgren, SEB's fixed-income strategist, said on Twitter.

The Riksbank has come in for heavy criticism from the likes of Paul Krugman, the Nobel prize-winning economist, for favouring rate increases in 2010 and 2011 to stem what it saw as a nascent housing bubble rather than tackling falling inflation.

The 50 basis point cut was justified by the "broad fall in inflation" - which was minus 0.2 per cent in May - and lower international policy rates, the Riksbank said.

It added that it now forecast that interest rates would slowly begin to rise from the end of next year.

Stefan Ingves, the Riksbank's governor and chairman of the Basel committee on banking supervision, and his deputy Kerstin af Jochnick were outvoted, with both arguing for an interest-rate cut of 25bp. It is the first time since the central bank became independent in 1999 that the governor has been outvoted in a monetary policy decision.

The cut takes the Riksbank's benchmark interest rate back to the same level it was between July 2009 and July 2010.

"The Riksbank is likely to increase talks of unconventional measures going forward, but will only take further actions if inflation expectations fall further," said Ms Blomgren.

The Riksbank was one of the few central banks globally to try a policy of "leaning into the wind" and trying to tackle Sweden's problem of high household debt and an overheated housing market through monetary policy.

Lars Svensson, a former Riksbank deputy governor, lambasted the approach of raising rates as having little impact on debt and a much bigger impact on inflation and unemployment.

The Riksbank continued on Thursday to warn about high debt levels with the average level of indebtedness to household income at about 174 per cent.

The central bank also trimmed its inflation forecasts for the next three years, lowering it from plus 0.2 per cent to minus 0.1 per cent for 2014 and from 2.2 per cent to 1.3 per cent next year. Analysts noted that the revisions were less than expected, raising the possibility of further cuts in its forecasts later.

"The low interest rates are already contributing to a relatively rapid increase in household debt as a percentage of household income. An even lower repo rate will strengthen this tendency, thus increasing the risk of the economy developing in an unsustainable way in the long run," the Riksbank added.

Sweden's financial regulator has already raised risk weightings for mortgages as it deployed the "macroprudential tools" which are being used by other central banks like the Bank of England.

The Financial Supervisory Authority warned banks late last year that it could increase them again from 15 to 25 per cent. Swedish banks already have some of the highest capital requirements in the world.

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