The adverse response to Sweden's Riksbank's decision last week to further cut policy rate below zero from -0.35% to -0.50% indicates investors' worries regarding the impact of negative interest rates on the profitability of the bank. Riksbank cited global uncertainty and low inflation for the rate cut. Due to concerns that the negative rates will impact bank's profitability, it worsened equity market sell-off last week and the drop in core euro area government bond yields.

Due to the unusually strong response from the market to the Swedish central bank's decision, the ECB might consider twice before cutting its deposit rate from the current -0.3% during its meeting in March. However, it is unlikely that this will be enough to deter the ECB from easing policy in March.

It is not conclusive that the negative rates in Sweden have hurt the real economy and financial sector. As the banking stocks of Sweden have usually underperformed their euro-zone counterparts since the Riksbank lowered the repo rate below zero last February, they have performed worse than Sweden's stock market as a whole.

Meanwhile, Sweden's bank lending growth has not declined. Indeed, bank lending growth to non-financial firms continues to be weak by pre-2008 standards; however, lending to consumers has continued to grow strongly. Furthermore, even if most banks have not passed on the cost of negative rates to their customers, there are certain signs indicating that this has been disastrous.

Moreover, even if all of Sweden's banks were struggling, this is not expected to deter the ECB, which has explicitly mentioned that bank profitability is not its priority. Indeed, there is a risk that the bank sector weakness will impact the GDP growth and price stability. However, this will definitely make the ECB more likely to take action.

The ECB has tools other than interest rate cuts, particularly the quantitative easing program that might help banks. ECB President Mario Draghi has highlighted recently that if the market volatility risked the transmission of its monetary measures by banks, then it will act.

"Accordingly, we expect the ECB to ease policy further at its next meeting, with a cut to the deposit rate, perhaps of 20bps, and an increase in its monthly asset purchases from €60bn to €80bn", says Capital Economics.