STOCKHOLM (Reuters) - An unexpected contraction in the Swedish economy in the first quarter of 2014 due to subdued exports and lower inventories fueled expectations that the central bank will cut interest rates at its next policy meeting in July.
Unexpectedly weak growth also highlighted the country's dependence on its vast export industry, including global blue chips Volvo and Ericsson, which face lackluster demand across much of Europe - its top market.
Finance Minister Anders Borg said weaker growth abroad had weighed on exports and that a pick-up was expected further out.
Prime Minister Fredrik Reinfeldt's centre-right government, facing elections in September that opinion polls suggest they will lose, is forecasting GDP growth of 2.7 percent this year, 3.3 percent in 2015 and 3.5 percent in 2016.
"Although signals are mixed, the years ahead look slightly stronger," Borg said in a written comment to Reuters.
Gross domestic product slowed down sharply from the 3.1 percent expansion in the previous quarter to 1.9 percent on a yearly basis and shrank 0.1 percent in the first quarter on a quarterly view, the statistics office said on Friday.
The figure was below analyst expectations for 0.1 percent growth in the quarter and 2.4 percent on the year. The Riksbank had forecast growth of 2.5 percent.
"All in all, this was on the weaker side of the Riksbank's outlook. GDP, unemployment, and inflation, all support an expected rate cut in July," Danske economist Michael Grahn said.
However, behind the weaker-than-expected headline figure some positive underlying trends were visible, among them investments that rose by 7.7 percent year-on-year.
Investments usually come late in a business cycle and are likely to continue to grow, meaning a lot of component should contribute to growth in the Swedish economy, Nordea analyst Andreas Wallstrom said.
He said the lower-than-expected headline GDP and, above all, the low inflation readings in recent months would persuade the central bank to cut rates at its next policy meeting in July, but that there would be no more cuts after that.
"If we are correct in forecasting that growth will broaden and that inflation picks up as well, we believe the Riksbank is done cutting after July," he said.
The economy stalled in late 2012 but had picked up sufficiently to post its best growth in three years in the final quarter of 2013, lifted by strong public and private consumption and a build-up of inventories to meet anticipated future demand. But recovery has been uneven with lingering weakness in exports hampering any sustained upturn while worries have grown in recent months that the standoff between Russia and the West over Ukraine could weigh on activity in a Europe still only limping out of its debt crisis.
Although the incumbent government is trailing the centre-left opposition by roughly 10-15 percentage points in recent opinion polls, neither side is expected to go on a spending spree to win support and boost the economy.
The Swedish crown weakened slightly against the euro on the news, but with expectations of a rate cut already largely priced in, government bond yields slipped only about 1 basis point.
Additional reporting by Bjorn Rundstrom and Mia Shanley; Editing by Louise Ireland