May 30 (Bloomberg) -- Sweden's economy grew at the slowest pace in four years in the first quarter as the global credit freeze curbed investment and shackled overseas demand for the nation's exports.

Gross domestic product rose 2.2 percent compared with a revised 2.9 percent in the previous quarter, Statistics Sweden said today. The median forecast of 22 economists surveyed by Bloomberg was for 2.7 percent. GDP grew a seasonally adjusted 0.4 percent on the quarter.

A drying up of worldwide credit markets, triggered by the U.S. subprime mortgage crisis, is damping global growth and squeezing demand for Swedish goods. Exports make up about half of the Nordic country's economy and trade with the U.S. represents almost half the trade surplus.

``This will dampen the desire of some policy makers to hike'' interest rates, said Dominic Bryant, an economist at BNP Paribas. ``Sweden might be entering a period of sustained below-trend growth.''

The krona declined as much as 0.3 percent to 9.3536 per euro, and traded at 9.3493 by 10:32 a.m. in Stockholm. The yield on the 5.25 percent government note fell 5 basis points to 4.44 percent.

Government consumption fell 0.3 percent in the quarter, while household spending gained 0.4 percent, down from 0.5 percent in the last three months of 2007 and 0.8 percent in the third quarter.

`Ugly Surprise'

``Sweden delivered quite an ugly surprise,'' Davide Stroppa, an economist at UniCredit Markets & Investment Banking, said in a client note. ``However, increasingly worryingly signals on inflation and inflation expectations are likely to keep the Riksbank on hold for this year.''

The Riksbank expects rising food and oil prices to keep the bank's preferred measure of inflation above the 2 percent target until 2011, preventing it from cutting rates to help growth.

The underlying inflation rate, excluding mortgage payments, subsidies and indirect taxes, rose to a five-year high of 2.4 percent in April from 2.3 percent in March. The Riksbank kept its key rate on hold at 4.25 percent on April 23.

``The step down in growth is unlikely to alleviate the Riksbank's inflation concerns in the near term, which continue to be fueled by significant commodity price increases,'' Nicola Mai, an economist at JPMorgan Chase & Co., wrote in a client note before the report.

Slowing Down

Sweden's forward-rate agreements, a kind of interest rate futures contract where investors bet on future repo rate increases, all declined after the report. The three-month contract settling December this year dropped 8 basis points to 5.1 percent.

Consumer confidence tumbled to a 4 1/2-year low in May, and exports to Europe, the country's biggest trading partner, will slow as higher borrowing costs sap both corporate and household demand, according to Bryant.

``Since last autumn, the storm clouds have gathered and somewhat darkened, worsening the outlook for growth,'' the Finance Ministry said in its preliminary spring budget on April 15.

As export growth slows and mortgage costs rise, economic expansion will slow to 2.1 percent this year and 1.8 percent in 2009, the Finance Ministry forecasts.

The government has slashed taxes by about 80 billion kronor since gaining power in 2006 to spur job creation and has signaled a third round of income tax cuts next year to shore up economic expansion in the face of sluggish global growth.

``As the economy slows, the underlying pressure on prices will subside,'' UBS Ltd. economist Sunil Kapadia wrote in a client note ahead of the report. Kapadia forecasts the central bank will lower rates by 0.5 percentage point in the second half.

To contact the reporter on this story: Robin Wigglesworth in Oslo at wigglesworth@bloomberg.net

Last Updated: May 30, 2008 04:44 EDT