The reduction is the largest ever cut in the repo rate since the Riksbank made it into Sweden’s benchmark interest rate in 1994.
“A large reduction in the interest rate and the interest rate path is necessary to dampen the fall in production and employment and to attain the inflation target of 2 percent,” the bank said in a statement.
The cut was welcomed by Cecilia Hermansson, chief economist at Swedbank.
“I think it’s good they take serious action and reduce the rate when one considers the state of the economy. There’s no clear risk of not meeting the inflation goal in a situation like this, so I think it’s absolutely right to cut the rate by so much,” said told the TT news agency.
In explaining its decision, the Riksbank cited the “rapid and clear deterioration” in economic activity since the bank’s executive board last met in October, when it trimmed the repo rate by 0.5 percent.
“Several economic indicators are at historically low levels. At the same time, the crisis in the financial markets is persisting, despite the forceful measures that have been taken around the world,” said the Riksbank.
“The financial turbulence has made it both difficult and expensive for companies and households to borrow money.”
The Riksbank said that a substantial interest rate reduction was needed because monetary policy is not having as great an impact as it normally does.
The bank added that it expects the repo rate to remain at 2.0 percent for the next year.
But Hermansson wouldn’t be surprised if rates fall even further.
“I think the uncertainty is so great that you can’t put too much emphasis on the interest rate path. What’s happened recently shows that you have to be flexible and have a monetary policy which is based on the situation in which you find yourself,” she said.
Hermansson also speculated that the huge rate cut was in some way an attempt by the Riksbank to correct past mistakes.
“I think they are aware that they led a wrongheaded monetary policy up through September. This is a way to take it back and bring down the interest rate path so that it better fits prevailing economic conditions,” she said.
The Riksbank believes the rate cut will help revive the economy stoping the drop in resource utilization.
However, economic recovery will also depend on other factors, according to the Riksbank, including increased demand from abroad, improvements in the financial system, and a weakening in the krona.
The bank said it expects inflation to “fall rapidly” in 2009 and remain below the Riksbank’s 2.0 percent inflation target for the next two years.