A MORNING rise in Swedish interest rates to head off higher inflation

was followed by Italy increasing its rates in the afternoon to defend

the sagging lira.

The Swedish central bank, the Riksbank, lifted two key interest rates

at a council meeting yesterday.

The pre-emptive move by the Swedish central bank against inflationary

tendencies in the economy surprised financial markets around Europe and

sent Swedish shares tumbling.

The Swedish economy was the first in Europe to emerge from the

recession. The hike in interest rates is controversial because it comes

in the middle of a general election campaign.

The bank raised its central repurchase rate to 7.20% from 6.92% and

its ceiling, or lending, rate to 8% from 7.50%.

''The purpose of the increases in the Riksbank's rates is to

counteract, at an early stage, a tendency towards higher inflation,''

bank Governor Urban Backstrom said.

The bank said the move was partly in response to ''general signs that

underlying inflation rate is at risk of climbing''.

The rate increases stunned Swedish financial markets, sending bond

yields sharply higher, the crown lower and shares plunging by more than

2.5%.

Mr Stefan Wictorin, debt analyst at Midland Bank, said: ''This has

surprised markets completely. The inflation picture has not altered that

dramatically.''

The Riksbank evidently disagreed and noted that expectations of higher

inflation were widespread. ''Surveys also show that inflationary

expectations among households and companies have risen,'' it added,

saying high bond yields and the weak crown also reflected uncertain

expectations.

The Bank of Italy is raising its official discount rate by

half-a-percentage point to 7.5%.

The last change to the discount rate was on May 12, 1994, when it was

cut by half-a-percentage point.

It was the first time since September 1992 that the Bank of Italy has

increased its discount rate.