Dec. 4 (Bloomberg) -- Sweden’s central bank cut the benchmark interest rate by 1.75 percentage points, the biggest reduction since 1992, and predicted the economy would contract next year, extending the current recession.

The Stockholm-based Riksbank said it lowered the repo rate to 2 percent, after bringing forward the date of its announcement by two weeks. The bank forecast the economy will shrink 0.5 percent next year after growing 0.9 percent in 2008.

“We needed to cut the rate to deal with the economic downturn and at the same time achieve our 2 percent inflation target,” Riksbank Governor Stefan Ingves said at a press conference.

The European Central Bank, the Bank of England and the central banks of New Zealand and Indonesia also cut rates today as the credit crunch looks set to trigger the first simultaneous recession in the U.S., Japan and the euro countries since World War II. The krona, which has fallen 11 percent against the euro since Aug. 22, weakened further following the announcement.

The krona fell 1.7 percent to 10.5965 against the euro by 3:43 p.m. in Stockholm, from 10.4160 yesterday. The yield on the 5.25 percent government bond due March 2011 traded eight basis points lower at 1.88 percent.

The Nordic region’s biggest economy contracted 0.1 percent in the third quarter, entering its first recession since 1993, the statistics agency reported on Nov. 28.

“The economy needed this,” said Torbjoern Isaksson, an economist at Nordea Bank AB. “This is an exceptional situation which demands exceptional decisions.” None of the 18 economists surveyed by Bloomberg predicted the size of the reduction.

Inflation Outlook

Headline inflation will slow to an average 1.2 percent next year from 4 percent in October, the Riksbank predicted. Prices will rise by an average 1.5 percent in 2010 and 2.1 percent in 2011, the bank predicted. Unemployment will rise to 8.4 percent in 2010 from 6.2 percent this year, it forecast.

“We expect a deeper recession than the one envisioned by the Riksbank and anticipate a more rapid fall in inflation,” Nicola Mai, an economist at JP Morgan Chase Bank in London, said in a note to clients. He expects that the policy rate will fall to one percent early next year or possibly even lower.

The Riksbank said it won’t start raising interest rates before 2010. “We estimate that the rate will remain around this level during 2009,” Ingves said.

The central bank forecast in October that it would only have to cut the key rate by a half-point in the next six months. SEB AB forecasts it will cut the rate to 1.5 percent or lower this spring.

Turnaround

The economy will start to recover in 2010 when it will grow by 2.2 percent, followed by 3 percent growth in 2011, the Riksbank said. “We anticipate a pretty quick turnaround,” Ingves said, as confidence returns to the financial markets on the back of measures to stimulate the economy by governments and central banks around the world.

The European Central Bank cut its key rate by 0.75 percentage point to 2.5 percent today, while the Bank of England reduced its rate by a full percentage point to 2 percent as recession concerns mount and the inflation threat diminishes.

“We’re facing a really cold winter,” Finance Minister Anders Borg said last week. “It will be long, it will be cold, it will be bitter.”

The government has said it will spend an additional one percent of GDP, or 32 billion kronor ($3.8 billion), next year on infrastructure, schools, health care and tax cuts for individuals and companies to cushion the economic slowdown. It said today that it may expand those plans as the economic outlook deteriorates.

Sweden’s largest builder, Skanska AB, said last week it will cut jobs, following a similar move by drugmaker AstraZeneca Plc and Sandvik AB, the world’s largest maker of cutting tools. The government is under pressure to help Swedish car brands Volvo and Saab on speculation their struggling owners Ford Motor Co. and General Motors Corp. may sell the units.

To contact the reporter on this story: Johan Carlstrom in Stockholm at jcarlstrom@bloomberg.net.

Last Updated: December 4, 2008 10:58 EST