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Swedish central bankers are now looking at the country’s 240 billion-krona ($30 billion) municipal bond market as a possible channel for further stimulus as its debt purchases risks distorting trading in government debt.

Riksbank Deputy Governors Martin Floden and Cecilia Skingsley on Tuesday said expanding purchases to also include municipal bonds could be an option if further measures are needed to lift inflation. Both said an even more expansionary monetary policy may be required as risks abroad are increasing.

While rates can be cut further and bond purchases expanded, “there’s of course a floor for the repo rate and a ceiling for the purchase of bonds,” Floden said. The “aim after all is to get inflation up in an orderly manner.”

The bank has unleashed unprecedented stimulus to fight off disinflation, including cutting rates to minus 0.35 percent, and starting a program to buy as much as 135 billion kronor in government bonds, or about 23 percent of the outstanding debt.

Extending purchases to also include municipal bonds would add a market of 230 billion to 240 billion kronor of krona-denominated assets, according to Charlotte Asgermyr, an analyst at SEB in Stockholm. The Riksbank could probably spend some 50 billion kronor on purchases of municipal bonds, she said.

Kommuninvest’s 2.25 percent bond maturing in 2019 rose Tuesday, driving the yield down to 0.30 percent. The spread to the swap curve narrowed to 16 basis points from 17 basis points. Kommuninvest, which is AAA rated, is the largest issuer of municipal bonds.

Graph of bond performance

Municipal bonds are “relatively secure assets, and it’s a market with low turnover, so if the Riksbank were to enter it might impact liquidity quicker than in the government bond market,” Floden said after a speech in Stockholm on Tuesday.

Jussi Hiljanen, head of fixed income strategy at SEB in Stockholm, said the Riksbank may have to start looking at other assets as any further extension of government bond purchases could start hurting how the market functions.

The “purchases have reduced liquidity in the market quite a lot and from that perspective, it’s becoming rather limited in terms of how much more it can buy,” he said by telephone on Tuesday. “The next step if the Riksbank would need to extend bond purchases would be to buy other assets and in such a scenario, it’s municipal bonds that would be very, very relevant.”

Skingsley, in an interview on Tuesday, said buying municipal bonds would “further contribute to expansion in the Swedish economy” even though she hasn’t taken a stance on whether it would be good to expand the purchase program to other bonds.

Floden warned that the Riksbank may be running out of meaningful tools.

“If the inflation outlook deteriorates more substantially, we could therefore end up in a situation where monetary policy can no longer do anything meaningful to raise inflation,” he said. “In such a situation we would be forced to accept that it would take longer to bring inflation up.”

The bank saw some relief on Tuesday, as underlying inflation was 1 percent in September, beating analyst estimates and in line with the Riksbank’s own forecast. Headline inflation was just 0.1 percent.

— With assistance by Charles Daly