Europe Economy

Can Sweden avert ‘Nordic Japan’ fate?

Stockholm, Sweden
Ellen Rooney | Robert Harding World Imagery | Getty Images

Swedish central bank meetings are generally as staid as you'd expect, but they have just got a lot more interesting, as the Nordic country contemplates the specter of Japan-style stagnation.

On Thursday, the Riksbank, Sweden's central bank, cut its main policy rate by 50 basis points to 0.25 percent, surprising the market, as most economists had forecast a 25 basis points cut to 0.5 percent. The Swedish krona tumbled to its lowest level against the dollar for close to a year, and its lowest level against the euro for more than three years, following the news.

‘Damaging deflation’ threatens euro zone: EY

The Riksbank has also signaled very strongly that it will not start cutting interest rates until the end of 2015, later than expected.

The meeting is "a lasting negative for the Swedish krona," according to Citigroup currency strategist Josh O'Byrne.

This may be bad news for Swedish tourists setting off on holiday this summer – but ultimately, good news for their country's economy, if it encourages exports of Swedish goods.

People walk on the street in Akihabara, Electric Town in Tokyo, Japan.
Deflation in Japan may finally be ‘dead’

Consumer prices are falling in Sweden, which means the country may be entering a prolonged period of deflation – one of the issues which has dogged the Japanese economy in the past couple of decades. Deflation can cause problems if it means that employment falls and consumers subsequently are not spending, which may lead to a shrinking economy.

Sweden also has high levels of household debt in common with Japan. The average indebted Swede owes close to three times their annual income – and the average mortgage borrower 370 percent of their annual income. Unemployment has remained stubbornly high, at around 8 percent, since 2011.

Households borrowing too much: Riksbank head
Households borrowing too much: Riksbank head

When the Riksbank started raising interest rates in 2010, it was criticized by economists like Paul Krugman, and its own ex-deputy governor Lars Svensson, who feared that the measure would cause deflation.

Yet there is still room to avoid the deflationary trap.

Sweden's economy is strong elsewhere, with growth of 2.7 percent forecast this year by the Riksbank, ahead of the broader euro zone, and stronger than the around 1 percent annual growth of Japan in the 1990s. And it should benefit from improved growth in the euro zone, particularly Germany.

"We think Sweden will manage to avoid a Japanese fate, providing that policymakers are not overly complacent," Jessica Hinds, European economist at Capital Economics, wrote in a research note.

- By CNBC's Catherine Boyle