Sweden's central bank lifted its benchmark interest rate

Sweden's central bank lifted its benchmark interest rate for the eighth time in 18 months and said it will raise it twice more this year as rising employment and slowing productivity growth threaten to fuel inflation. The krona surged the most in almost five years.

The repurchase rate was raised a quarter-point to 3.5 percent, the highest in more than four years, the Stockholm-based bank said in an e-mail today. The rate may be raised to ``around'' 4 percent by year-end, up from an earlier forecast of 3.5 percent, and to 4.4 percent in two years, the bank said.

``This was more aggressive than the market had expected,'' said Henrik Mitelman, chief bond strategist at SEB Merchant Banking in Stockholm. ``It's reasonable that they adjusted their rate forecast up, but I think there's going to come even more rate increases.''

The bank is picking up the pace of rate increases as falling unemployment pushes up wages and after productivity growth stalled at the beginning of the year. The government has also cut taxes to stimulate demand, fueling an economic expansion that last year reached a six-year high.

The yield on two-year bonds surged 12 basis points, or 0.12 percentage point, to 4.15 percent as of 12:22 p.m. in Stockholm. The krona rallied as much as 1.3 percent to 9.288 per euro, the biggest one-day gain since Sept. 16, 2002.

Today's increase was expected by all 27 economists surveyed by Bloomberg.

Rate Outlook

``The Swedish economy is doing well and this means price pressures are increasing,'' Riksbank Governor Stefan Ingves said at a press conference in Stockholm. ``We have to raise the rate over the coming years to meet our inflation target.''

Given the forecasted rate increases, the Riksbank expects annual underlying inflation to reach its 2 percent target in one year and then remain at that level for the following two years. It lowered its forecast for growth this year to 3.1 percent from a February forecast of 3.5 percent. The economy will expand 3 percent next year and 2.3 percent in 2009, the bank said.

The Riksbank also said today that the economy risks ``overheating'' because a rapid decline in unemployment is causing labor shortages and because of slowing productivity growth. In such a scenario, the repo rate may be raised to more than 5 percent, the bank said.

Global Trend

Central banks are raising rates worldwide to curb inflation. Global economic expansion is expected to reach almost 5 percent for a fourth consecutive year in 2007, the International Monetary Fund forecasts. The European Central Bank on June 5 raised its benchmark rate to 4 percent, the highest since 2001, and Norway's bank increased its key rate to 4.25 percent last month.

Swedish policy makers have been able to keep rates lower than most of their peers in Europe as inflation has been slow to pick up amid a surge in productivity and increased imports from lower- cost countries such as China.

Underlying annual inflation, the Riksbank's preferred measure, was 0.9 percent in May, the lowest since February 2006. Inflation has held below target since September 2003.

Inflation pressures are now mounting as the labor market tightens and productivity growth slows. The National Institute of Economic Research yesterday recommended the bank raise the benchmark rate to 4.75 percent in 2009.

``The new assessment means that the repo rate needs to be raised more in the future than was considered justified in February,'' the Riksbank said today. ``This is because the labor market has tightened, the central wage agreements have been higher and fiscal policy has been more expansionary than the Riksbank estimated at the time.''

Productivity Growth

Productivity growth stalled in the first quarter, with hours worked rising 3 percent, the same as gross domestic product. The average gap between the growth in hours worked and growth in the economy was 2.5 percentage points last year.

The bank today slashed its forecast for productivity growth to 1 percent from 1.7 percent and said productivity will rise 2.1 percent next year and 2.1 percent in 2009. Productivity growth was 2.4 percent last year.

The unemployment rate fell to 3.9 percent last month, the lowest since November 2002, from 4.8 percent a year earlier, according to a labor survey by Statistics Sweden reported today. Employment rose by 136,000 to 4.432 million in the year. The bank forecast unemployment of 4.7 percent this year, on average, and 4.5 percent next year.

``The report confirms that labor market tightening in Sweden is very rapid, adding to the risk of a sharp pickup in wage and price inflation next year,'' said Nicola L. Mai, an economist at JPMorgan Chase & Co., in a note to clients.

source:www.bloomberg.com