OREANDA-NEWS. February 13, 2015. The Swedish central bank sent its base interest rate into unprecedented negative territory on Thursday and said it would buy up government bonds in a bid to ward off deflation.

The bank dropped its zero interest rate to -0.1 percent and announced it would buy 10 billion kronor (\\$1.18 billion, 1.04 billion euros) of government bonds to try to lift Sweden's inflation rate -- which has hovered around zero for two years -- closer to its two-percent target.

"There are signs that underlying inflation 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.

Price levels in Sweden 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.

- 'Unique' bond purchase -

The Swedish central bank changed course to boost inflation by lowering its interest rate in mid-2014 after coming under fire for not doing more to respond to the deflation threat.

"We're ready to make our monetary policy even more expansionary," central bank chief Stefan Ingves told reporters Thursday.

His announcement comes weeks after the European Central Bank announced a bond-buying spree worth 1.14 trillion euros to drive eurozone inflation up.

Sweden is now the first medium-sized economy to apply outright quantitative easing measures in a purchase that targets bonds with maturities of one to five years.

"This puts the spotlight on the low inflation rate. That is the central bank's big problem," SEB bank chief economist Robert Bergquist told AFP.

He called the bank's decision "unique" in that Sweden -- whose economy grew by 1.8 percent in 2014 -- has taken to bond-buying despite being far from a recession.

But whereas the ECB programme is worth 10 percent of eurozone GDP, Sweden's purchases amount to only 0.3 percent of the national economy.

"It's pretty tiny," said economist Jonathan Loynes at the research consultancy firm Capital Economics.

"I can't imagine there'll be huge knock-on effects," he added.

But the central bank's QE announcement sent the Stockholm stock exchange's main index shooting up 1.97 percent to a record close.

"As has happened in other economies, some of the additional krona created will likely make its way into Swedish stocks so the reaction from markets today is front running that phenomenon," said CMC Markets UK analyst Jasper Lawler.

Bond-buying programmes 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.

"The reason one wants a weak currency is that there often aren't many other tools to stimulate growth," said chief economist Robert Bergquist at Swedish bank SEB.

- 'A free lunch' -

The bank hopes its cut to the base rate will cheapen the cost of lending in Sweden, although it is already at historically low levels, thus leading to more investment and consumption.

Sweden's base interest rate serves as a reference for rates on the monetary market and those set by private banks, which are slightly higher.

However some economists expressed concern about the level of household debt in Sweden, among the highest in the world.

"There is a great risk of bad investments. A free lunch will cost you in the long run," said Nordea bank's chief economist Annika Winsth.

Swedish price levels have yet to take a toll on overall GDP growth -- at 1.8 percent in 2014 and forecast at 2.7 percent 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.

Thursday's move into quantitative easing may have been timid, but it is unlikely to be the last.

"This is a first tentative step into unconventional policy territory," Loynes said.

"There's a pretty strong sign post there's more coming -- more interest-rate cuts and quantitative easing," he added.