Sweden’s central bank performed a dramatic U-turn on Thursday as it raised interest rates, said it would shrink its balance sheet and warned of more increases to come as it belatedly responded to surging inflation.

The Riksbank reversed the stance it had adopted at its previous meeting in February, when it said it would only lift interest rates from zero towards the end of 2024. On Thursday, the bank raised its main repurchase rate to 0.25 per cent and forecast that rates were likely to reach 1 per cent by the end of the year.

Sweden’s central bank has been surprised by the strength of inflation, but it forecast prices would increase 5.5 per cent this year, well above its previous forecast of 2.9 per cent and its target of 2 per cent.

“Inflation has risen to the highest level since the 1990s and will be high for some time. To counteract the high inflation from becoming entrenched in price and wage-setting, the executive board has decided to raise the repo rate,” the Riksbank said in a statement.

The central bank has long struggled with its inflation mandate, raising rates in 2010 only to have to cut them to below zero afterwards, a move often cited as a cautionary tale against monetary tightening by the US Federal Reserve.

It then followed with a five-year experiment with negative rates, ending only in December 2019 after parts of the financial industry complained that it was hitting profits.

Coming out of the Covid-19 pandemic and with the addition of energy and food price shocks from Russia’s invasion of Ukraine, the Riksbank stood out with its call in February to keep rates at zero for years to come even as other central banks tightened policy. It has now joined the global consensus in tightening policy to counteract rising inflation.

The Swedish central bank warned that it was “more uncertain than usual” about how inflation would behave in the coming months and added that “the risk outlook . . . is on the upside”, meaning rates could be higher than forecast.

“The Riksbank finally bowed to economic logic . . . and today’s announcement completes a remarkable U-turn from the Bank’s thus-far decidedly dovish stance,” said David Oxley, senior Europe economist at Capital Economics.

The Riksbank also said that it would slow the pace of its asset purchases in the second half of the year, meaning its balance sheet would start to shrink. It will buy SKr37bn ($3.6bn) of bonds in the second half of the year, half the level of the first six months.

Sweden’s growth is expected to slow considerably at the same time that inflation rises, with GDP now forecast at 2.8 per cent for this year and 1.4 per cent for 2023, both lower than February’s forecasts of 3.6 and 2 per cent, respectively.

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