This week, Sweden’s central bank, the Riksbank, surprised the market by cutting its benchmark interest rate to zero. The cut was larger than expected, as the market was looking for only a 10-15 bp rate cut. This aggressive move puts Sweden’s main repurchase rate, or repo, lower than it was before the Lehman crisis, and lower than the European Central Bank’s (ECB) repo rate of 0.25%.

What’s interesting is that this bold move is a complete reversal of Riksbank’s previous policy. Back in July 2010, the central bank had started to raise rates to curb Sweden’s overheated housing prices and household debt.

At one point the repo rate touched 2%. But then from December 2011 on, Riksbank began seeing a drop in consumer prices and started to ease its monetary policy. Many felt that easing process was too slow. The central bank was criticized as quick to respond to inflation but slow to respond to deflation, and they were lumped into central banking’s “Hall of Shame” with other central banks that flip-flopped their monetary policies, such as the Bank of Japan in 2000 and the ECB in 2011.

Today the same level of household debt persists. Not only that, Sweden’s gross domestic product growth is one the strongest among developed nations, standing above 2% for the first half of 2014, and forecasted to grow faster in the second half. So clearly, the Bank’s decision to chop rates to 0% was not based on growth concerns. It was based on the material concerns of “lower inflation trend,” as consumer prices in Sweden have dropped in seven of the past nine months. The Bank now forecasts inflation to be at just 0.4% in 2015, which is still well below its 2% target.

My view: A country that wants more inflation would like to see its currency remain weak. I believe if the Swedish krona (SEK) should start to strengthen against the U.S. dollar – or more importantly against the euro – there will be a good chance that the Riksbank will intervene to sell the SEK in order to buy time until its inflation level hits the desired 2%.

This report is for general information and education only and was compiled from data and sources believed to be reliable. City National Bank does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors as of the date of the report with no obligation to update or notify of inaccuracy or change. This report is not a recommendation or an offer or solicitation to buy or sell any financial instrument discussed. It is not specific investment advice. Financial instruments discussed may not be suitable for the reader. Readers must make an independent investment decisions based on their own investment objectives and financial situations. Prices and financial instruments discussed are subject to change without notice. Instruments denominated in a foreign currency are subject to exchange rate and other risks. The Bank (and its clients or associated persons) may engage in transactions inconsistent with this report and may buy from or sell to clients or others the financial instruments discussed on a principal basis. Past performance is not an indication of future results. This report may not be reproduced, distributed or further published by any person without the written consent of City National Bank. Please cite source when quoting.