They are trying everything they can to push banks to lend..... Bankers watch as Swedish interest rates goes subzeroStory Highlights Swedish Riksbank is the world's first central bank to have negative interest rates Move is designed to encourage commercial banks to boost lending Bank of England governor has hinted he may follow the Swedish example Fears are rising of a liquidity trap, where cash from banks don't filter to economy August 28, 2009 -- Updated 0352 GMT (1152 HKT)Next Article in World Business Â» By Andrew Ward and David Oakley For a world first, the announcement came with remarkably little fanfare. Sweden is entering subzero interest rates, the first country to do so. But last month, the Swedish Riksbank entered uncharted territory when it became the world's first central bank to introduce negative interest rates on bank deposits. Even at the deepest point of Japan's financial crisis, the country's central bank shied away from such a measure, which is designed to encourage commercial banks to boost lending. But, as they contemplate their exit strategies after the extraordinary measures of the past two years, central bankers will be monitoring the Swedish experiment closely. Mervyn King, the Bank of England governor, has hinted he may follow the Swedish example as the danger of a so-called liquidity trap, where cash remains stuck in the banking system and does not filter out to the wider economy, is an increasing concern for the UK. Hoarding is exactly what happened in Japan earlier this decade when the Bank of Japan implemented quantitative easing between 2001 and 2006. Japanese banks refused to lend, in spite of central bank stimulus, because of fears over the dire state of the economy. If this continues to happen in other economies, central bankers may be left with little choice but to follow the Swedish example. John Wraith, head of sterling rates product development at RBC Capital Markets, says: "The success of the UK's quantitative easing experiment hinges a lot on whether the banks will use the extra money they are getting for lending to individuals and businesses. "If there is no sign of this over the next few months, then the Bank of England might consider a negative interest rate. In essence, it is a fine on banks that refuse to lend." In the UK, for example, nearly Â£140bn has been injected into the economy through central bank purchases of government bonds and corporate assets, mainly from the commercial banks. However, since the QE project was launched on March 5, a lot of this money, which in theory should be used by the commercial banks for lending to businesses and individuals, has ended up at the Bank of England in reserves. Commercial bank deposits have risen from Â£31bn in early March to Â£152bn at the end of July -- the latest figure. This in itself is not a problem as the banks could be using this big increase in their reserves to step up their lending to the private sector. The more the banks have in reserves, the more they are allowed to lend. However, there is no sign yet that they are using their much bigger reserves to lend on. The latest money supply figures for lending are still fairly anemic. It is why Mr King did not rule the possibility of negative interest rates when asked about the Riksbank model this month following the unveiling of the quarterly inflation report. "It's an idea we will certainly be looking at, whether the effectiveness of our asset purchases could be increased by reducing the rate at which we remunerate reserves," he said. His comments are one reason why yields on short-dated UK government bonds have fallen to record lows and why sterling has been under pressure in the currency markets. Initially, Mr King gave QE six months before it would start taking effect. That time limit is up next week. If there are no signs in the money supply numbers, particularly in the key M4 lending excluding financial institutions, then the policy may start to look a distinct possibility. In Europe, the European Central Bank is considered less likely to introduce negative interest rates. This is because it has maintained higher official rates than other banks and used money market operations to act as a stimulant instead. For example, it offered commercial banks unlimited funds for one year at the end of June. But it does have the same problem as the Bank of England in assessing the success of its policy. Like the UK, commercial bank deposits at the ECB have shot up in the past few months. At this stage, the US also seems unlikely to introduce the policy as there has been little debate on the matter and no hints from policymakers about it being an option. At the Riksbank, which now has a deposit rate of minus 0.25 per cent, the most vocal advocate of the policy is deputy governor Lars Svensson, a world-renowned expert on monetary policy theory and a close associate of Ben Bernanke, chairman of the US Federal Reserve, since they worked together at Princeton University. According to the minutes of the Riksbank's July meeting, Mr Svensson dismissed the "zero interest rate mystique" that had "exaggerated the problems" associated with zero or sub-zero rates. "There is nothing strange about negative interest rates," he said. Henrik Mitelman, chief fixed income strategist at SEB, the Swedish bank, said that the negative deposit rate, combined with a cut in the repo rate to an historic low of 0.25 per cent, sent a powerful signal to the market that the Riksbank intended to keep rates close to zero until economic recovery was well under way. "What the Riksbank did was very brave. They decided to see if markets could cope with it and the markets have." Carl Milton, fixed income analyst at Danske Bank in Stockholm, cautions that the Riksbank decision was not as pioneering as some have portrayed. The Bank routinely keeps its deposit rate 50 basis points lower than the repo rate to regulate liquidity in the market, he says. When the repo rate was cut to 0.25 per cent, the deposit rate was automatically forced into negative territory. "It was not something put in place to punish banks or to force them to lend," he says. Moreover, Swedish banks make relatively little use of the central bank deposit facility, limiting the impact of negative rates. But by breaking the taboo surrounding sub-zero rates, the Riksbank may have set an important precedent that others could use to greater effect. Don Smith, economist at Icap, says: "Sweden's policy is certainly very interesting. We will have to wait and see what happens there. This is certainly a very unusual policy, but these are very unusual times."