(Adds comments, background, detail, ESV budget forecast)
By Niklas Pollard
STOCKHOLM, Dec 19 (Reuters) - Sweden's National Institute of Economic Research (NIER) on Friday gave a sombre outlook for the Nordic country's economy, predicting a sharp contraction and rising unemployment next year due to the global downturn. The institute said the government was seen expanding stimulus measures in the two coming years to soften the blow and budget watchdog ESV in a separate statement predicted Sweden would swing to a central government deficit in the coming years.
NIER, a state-sponsored institute which produces economic forecasts for the government, said it expected the Swedish economy to shrink 0.9 percent in 2009. That compared with a previous forecast made in October for a 0.1 percent contraction.
"The global slump and financial crisis will have a great impact on the economy in Sweden in 2009 -- exports will decline, consumption all but stagnate, investments will fall, the labour market will weaken and GDP is expected to continue falling in the first quarter of 2009," the institute said.
"Due to an expansive fiscal policy, among other things, GDP growth will turn positive again during the second half of 2009, but growth will continue to be very weak."
In an effort to mitigate the effects of the global financial crisis, which has pushed a growing number of Sweden's key export markets into recession, the central bank was expected to cut interest rates to 1.0 percent by the end of next year.
"I believe we here at Danske have been pretty bearish on growth and have been expecting very low inflation, but we have been largely surpassed in this by the think tank," Danske Markets economist Michael Grahn said.
"Growth is falling and inflation is falling, and that could turn into something very nasty of course."
MORE STIMULUS
The Riksbank earlier this month slashed its repo rate 1.75 percentage points to 2 percent -- the biggest cut by far since the rate was introduced in 1994 -- and the central bank has said it expected rates to stay at that level in the coming year.
The government is set use strong public finances to carry out fiscal stimulus measures to stave off the worst of the economic downturn, the institute said.
It said it assumed parliament will pass new unfinanced revenue reductions and spending increases of about 7 billion crowns in 2009 and about 50 billion more in 2010.
Sweden's National Financial Management Authority (ESV) said separately it expected the country's central government budget to run into deficit next year for the first time since 2004.
The budget watchdog forecast a deficit of 6.8 billion Swedish crowns ($885 million) in 2009, compared with a previous forecast in September for a 62.2 billion crown surplus.
The deficit was seen widening to 38.9 billion crowns in the following year before coming down to a 4.2 billion shortfall in 2011.
"The financial crisis and the slowing economy are contributing to state finances deteriorating substantially in the coming three years," the agency said.
"But we have a considerably better starting point than we did ahead of the last downturn at the beginning of the decade."
The NIER predicted modest deflation in 2009, with the consumer price index forecast to fall 0.2 percent in the year versus a previous forecast for a 1.2 percent increase.
Unemployment was seen rising to 7.9 percent next year from 6.1 percent in 2008 with a further increase to 9 percent predicted for 2009, the institute said.
(Reporting by Niklas Pollard, Adam Cox and Sarah Edmonds; Editing by Andy Bruce)