July 3 (Bloomberg) -- Sweden’s economy will recover faster than the euro area after policy makers responded to the economic crisis with deeper interest-rate cuts and bigger stimulus measures, according to UBS Ltd. economist Sunil Kapadia.

“I expect Sweden to outperform Europe,” said Kapadia, the only one of 17 economists surveyed by Bloomberg to predict the Riksbank’s quarter-point rate reduction to 0.25 percent yesterday. “It was a very good move; the recovery that we’ll see is in part related to what the Riksbank has done, and that’s why Sweden will outperform the euro area, because the effect of fiscal and monetary stimulus will be more significant.”

The largest Nordic economy sank into its first recession since 1992 last year as a global decline in trade eroded demand for exports, which account for about half national output. The reductions in the benchmark rate, which matches the key Swiss rate as Europe’s lowest, represent a stark reversal of policy as the Riksbank was the last major central bank to raise rates just two weeks before the collapse of Lehman Brothers Holdings Inc.

“When they hiked rates that summer, that was clearly in hindsight a mistake,” Kapadia said. “They didn’t really understand the risks that were on the horizon and they were concentrating too much on the inflation target.”

Inflation is now less of a threat to the Swedish economy than deflation. Annual consumer prices have declined for two consecutive months and fell 0.4 percent in May. Prices will fall 0.2 percent on average this year, the Riksbank estimated yesterday. That compares with the bank’s 2 percent target.

Green Shoots

Riksbank Deputy Governor Lars E. O. Svensson, who voted in favor of a cut to zero yesterday, has argued that policy needs to overshoot the inflation goal to ensure average price growth reaches the target. Inflation will average 3.2 percent in 2011, the bank reiterated yesterday, exceeding the upper limit of the target range.

Just as the Riksbank in September continued to raise rates after the financial crisis had spread to the real economy, policy makers’ decision to lower rates yesterday follows the first signs of an economic recovery, sparking concern the bank may again be behind the curve.

“Despite tentative signs of green shoots appearing, the Riksbank reduced interest rates and remains committed to keeping them at this rate for a prolonged period,” Ben May, an economist at Capital Economics Ltd. in London, said in a note.

The economy will contract 5.4 percent this year, more than neighboring Norway and Denmark, before returning to growth of 1.4 percent in 2010. Signs of a recovery are already appearing in some consumer and industry indicators.

‘Desired Effects’

Swedish manufacturing unexpectedly ended an 11-month contraction in June, a survey showed on July 1, as companies began to build up inventories on the prospect of a return in export demand. Retail sales rose more than economists forecast in May, gaining for a second consecutive Month.

“The point is that if the recovery happens to the extent to which we expect it to, then this in part should be attributed to rate cuts having the desired effects,” Kapadia said. “We don’t know yet whether the bounce in lead indicators has just been an inventory-led phenomenon or a real demand-based phenomenon.”

Sweden’s benchmark index of the 30 most-traded stocks has gained 20 percent this year, compared with a 3.2 percent decline in the Dow Jones Euro Stoxx Index of 50 companies. The krona slumped 1.6 percent against the euro yesterday following the rate cut announcement and is the second-worst performer against the euro after the Canadian dollar of the 16 major currencies tracked by Bloomberg since June 1.

“In the near term, the krona is likely going to weaken,” Kapadia said. “But in the longer term the krona is a buy because fundamentally the economy is a lot more stable than a lot of other parts of Europe; the monetary and fiscal stimulus will have a greater effect than on average in Europe, so I expect Sweden to outperform Europe. Over the next 12 to 18 months, the krona is going to appreciate.”

The Riksbank said yesterday the main rate will average 0.3 percent until the third quarter of 2010.

To contact the reporter on this story: Tasneem Brogger in London at tbrogger@bloomberg.net

Last Updated: July 3, 2009 02:55 EDT