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 yesterday'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 two-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 -0.2 per cent in May – and lower international policy rates, the Riksbank said.– Copyright The Financial Times Limited 2014