* Growing expectations Riksbank rates could go to zero
* Central bank seen considering money supply measures
* Riksbank could buy assets such as mortgage-backed bonds
By Niklas Pollard and Daniel Dickson
STOCKHOLM, March 12 (Reuters) - Faced with the worst economic downturn in living memory, the Swedish central bank is likely to follow Britain and embark on asset purchases with newly created money this year.
This unorthodox method of financial resuscitation -- once employed by Japan with mixed results and now being tested by the Bank of England -- is considered a high-risk strategy that comes after all other ideas are exhausted.
An unprecedented string of interest rate cuts brought the Riksbank's key repo rate to 1.00 percent from nearly 5 percent five months ago, and the government unveiled $1 billion of stimulus measures at the end of last year and is seen presenting further measures in its spring budget, due mid-April.
But as the global downturn savages Sweden's export-dependent economy, quantitative easing is now a distinct possibility if the last-ditch bout of rate cuts and fiscal stimulus fails to stem the slide.
"First of all, we think the Riksbank will go to zero rates, which means that this avenue for stimulating the economy is closed after that and that one will have to take other types of measures," SEB economist Elisabet Kopelman said.
"This would be the type of measures which one usually labels quantitative easing."
Quantitative easing is a kind of steroid injection for an economy where the central bank floods the banking system with money -- more than is needed to keep official interest rates at or around zero -- to boost lending and ward off the threat of deflation.
Britain launched a 75 billion pound ($103 billion) scheme of quantitative easing this week in a move closely watched by peers looking for ways to come to grips with the downturn.
The Federal Reserve has also carried out massive asset purchases that might be regarded as a form of quantitative easing while European Central Bank policymakers have said they are considering all options to extend its monetary toolbox.
Peter Kaplan, chief economist for the Nordic region at RBS, said the Riksbank was likely to purchase long mortgage-backed bonds and commercial paper with newly created money once the tools of rate cuts and fiscal stimulus were expended. "I think they will choose this 'brute force' route and opt to buy these assets out-right," Kaplan said.
But such measures carried risks, he added.
"The state takes on a lot of credit risk, it weighs on the state's overall ability to borrow money and the borrowing cost will probably be more expensive. Resource allocation will also be less effective."
LIFE AT GROUND ZERO
The central bank -- the world's oldest -- has signalled further easing is in store and a growing number of analysts expect the repo rate to be slashed to close to zero in the coming months.
With no room left to stimulate an economy that contracted at a record 4.9 percent year-on-year in the fourth quarter with rate cuts, the central bank has begun eyeing less conventional measures to provide relief.
In its latest monetary policy report, published alongside the February rate cut to 1.00 percent, the Riksbank pointed to several ways of conducting monetary policy if its key repo hit zero, either by affecting inflation expectations or by working with credit spreads.
Deputy Governor Lars Svensson, who has carried out extensive research on the topic, has suggested the Riksbank could announce a temporary, higher price level target which, if that in itself proved insufficient to boost inflation expectations, could be followed by a policy of depreciating the crown.
However, the minutes of the Riksbank's February policy meeting showed other board members were loath to abandon, even temporarily, the central bank's 2 percent inflation target, as this could jeopardise the credibility of the Riksbank.
Danske Bank analyst Michael Grahn said the Riksbank was more likely to extend the scope for companies and households to borrow at longer maturities than resort to the solutions suggested by Svensson.
"He has discussed a very extreme situation," Grahn said, adding that Svensson's remarks had probably contributed to the crown weakening to record lows against the euro in recent weeks.
While Grahn does see rates falling to nearly zero, he did not expect the Riksbank to move ahead with quantitative measures unless the severe economic contraction extended into next year or expectations for a long run of deflation became cemented.
Inflation expectations have plunged lately, yet so far, neither markets nor households were anticipating deflation.
"But there are no real signs of a turn in positive direction any time soon," he said. (Editing by Andy Bruce)