This is the mainstream approach to negative supply shocks:

“Don’t let relative value stories turn into inflation stories.” (as the Fed used to say)

And, they say, if you wait for the economy to get strong bringing the higher rates of inflation down gets more than that much harder.

STOCKHOLM, Sweden – Sweden’s central bank on Wednesday made a surprise increase in its key interest rate by a quarter of a percentage point to 4.25 percent in a move to keep inflation in check.

The hike surprised many market watchers who had expected the Riksbank to either cut its benchmark repo rate or keep it unchanged at 4 percent.

“There were expectations on a reduction. It was a surprising increase,” Handelsbanken analyst Marcus Hallberg was quoted as saying by Swedish news agency TT.

The bank said it expects the interest rate to stay “roughly” at the same level for the rest of the year. But in Wednesday’s announcement, the bank warned that “there is still considerable uncertainty regarding the economic outlook and inflation prospects,” and cautioned that while it currently expects the repo rate to stay near the new level, “there is considerable uncertainty in this assessment.”

The bank’s further course would depend on how economic developments abroad affect Sweden’s economic activity and inflation, it said.

Although economic activity remains strong, the bank said it deemed inflation to be high, and the rate rise will help to bring inflation back toward the target of 2 percent “a couple of years ahead.”

Inflation, or consumer price index, has been rising steadily in recent years and is now at 3.5 percent.

The bank said that “gross domestic product growth will slow down over the year and the increase in employment will slacken. Resource utilization in the economy will nevertheless be higher than normal.”

Inflation has been pushed up mainly by higher food and energy prices as well as cost pressures.

The bank said the continued global market financial turmoil and the unrest in the U.S., has led to “great uncertainty” and that recent developments in the financial markets mean that “the risk of weaker growth in the world economy has increased.”

Davide Stroppa, an economist at Bayerische Hypo- und Vereinsbank AG, described the raise as a “shock” in a research note.

“As we see it, with today’s move, the Riksbank exploited the window opportunity to deliver a hike before it will be too late and the dilemma of risks of a slower (although still quite respectable) growth and higher inflation would be solved in favor of the former.”

Sweden’s repo rate was last raised in October, by a quarter of a percentage point to 4 percent.


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