Recent political and academic debates in Sweden have been dominated by a view of urban problems as endogenously generated by the spatial concentration of individuals with similar ethnic and socioeconomic characteristics within the same neighbourhoods. The impact of welfare state retrenchment on income inequality and residential segregation instead remained an under-investigated and somehow neglected issue in recent research. This paper aims at filling this gap by analysing income inequality dynamics in Malmö in the period 1991-2008. This city offers an interesting case of analysis, given the high rates of social problems compared to other Swedish cities. The results reveal that the increase in income inequality in Malmö has been especially due to the reduced redistributive impact of the Swedish welfare state. Furthermore, the increase in residential segregation by income can be attributed to the parallel increase in citywide income inequality rather than to an alleged increase in neighbourhood sorting.