Riksbank raises repo rate to 0.5 percent

The repo rate was last amended in July last year, when it was lowered by 0.25 percentage points to a record low of 0.25 percent.

"The Swedish economy is developing strongly following the severe downturn," the bank said in a statement. "The repo rate now needs to be raised gradually towards more normal levels to attain the inflation target of 2 per cent and to ensure stable growth in the real economy."

It added, "At the same time, economic growth abroad is expected to be lower, which means that the repo rate in the longer term will not need to be raised as much as was previously assumed."

The Riksbank now forecasts an average repo rate of 0.5 percent in the third quarter, 0.9 percent in the fourth quarter, 2.1 percent in the third quarter of 2011, 3.1 percent in third quarter of 2012 and 3.8 percent in third quarter of 2013.

In the Monetary Policy Update in April, the Riksbank predicted a slightly lower rate at the beginning of the forecast period. For the later portion of the forecast period, the projection was adjusted downwards.

The Riksbank expects Sweden's GDP to grow by 3.8 percent this year, 3.6 percent in 2011 and 2.8 percent in 2012, while the consumer price index is seen rising by an average of 1.2 percent this year, 2 percent next year and 2.4 percent in 2012.

The Riksbank warned that rising house prices and excessive lending could threaten economic development, but property agency Svensk Fastighetsförmedling does not believe that the interest rate hike will significantly affect the housing market.

"The increase is already mortgaged and banks have already begun to raise mortgage rates," CEO Peeter Pütsep wrote in a statement. "What is crucial in the future is the pace of the increases and it will be interesting to follow the interest rate path."

The interest rate path has taken a prolonged declined and is now expected to be 3.31 percent at the end of 2012, compared with 3.75 previously.

Short-term rates will rise on the Riksbank's interest rate statement, but long rates will fall, according to Cecilia Skingsley, chief analyst for interest rates and currencies at Swedbank.

"The increase was as expected, but other strains were softer than expected," she said. "The Riksbank wrote down the growth outlook for the Swedish economy and the interest rate path more than expected."

The strong growth has contributed to unemployment falling faster than previously projected, according to the Riksbank, which was estimated at just over 7.5 percent by the end of the forecast period.

The Riksbank also assessed that reforms in unemployment and health insurance and work tax credits have increased incentives to remain in the workforce. As such, the labour supply increased during the crisis despite falling employment.

In addition, it drew up some alternative scenarios for economic development. One would be the debt crisis worsening in Europe, which would lead to the growing economy falling back into a recession with lower interest rates.