Defending champion Annika Sorenstam, who clinched a career Grand Slam by winning the British Open a week ago, had two eagles but finished two strokes back in her first hometown tournament since 1999.
The 18th hole, surrounded by a huge gallery that included many of the record 21,500 fans who saw the final round, was used each time for the playoff.
Gustafson and Pettersen, both LPGA Tour regulars, parred the hole the first two times. Then, the Norwegian opened the door for the Swede, blowing a short par putt. Gustafson made no mistake.
'To beat Annika before such big crowds in Sweden is big,' Gustafson said. 'This is one of my biggest. It's hard to compare with my LPGA wins, but this is as big as winning the (2000) British Open.'
Gustafson could have won it on the 72nd hole, but missed a short putt.
'I was disturbed by a photographer,' she said. 'My caddie tried to calm me down, but I didn't get over it until the third playoff hole.'
The victory was especially sweet for the big-hitting Gustafson, who finished second, third and second the last three times in Sweden when the tournament was called the Compaq Open.
Pettersen improved the course record, set Saturday by Gustafson, by one stroke with a 10-under-par 62 to set up the playoff. Gustafson shot 68. Both finished regulation at 269, 19 under par on the Drottningholm course near the Royal castle.
Sorenstam finished alone in third place at 271 after a 68. She tied her finish in her first Ladies European Tour event outside Stockholm in 1992. Since then, she has won four LET events in Sweden.
Sorenstam showed why she's the world's top-ranked female golfer, finishing eagle-eagle on the front nine. But she was still two shots behind Gustafson, who made four birdies on the first nine holes.
'Of course I'm a little bit disappointed that I didn't win today, but I think I played well,' Sorenstam said. 'You just have to congratulate Sophie and Suzann, who played incredible golf today and all week long. You can't do more if you do your best.'
Sorenstam lost another shot to Gustafson on the 11th, where she made a bogey after a rare miss with her driver.
'If you play more aggressively, you take more chances. I had to take chances, especially on the last nine,' she said.
For Gustafson, it was the 15th victory in 223 tournaments since turning pro in 1992. The 29-year-old has three wins on the LPGA Tour. In 21 events this year, she made the cut 16 times and won once at the Irish Open in June.
Laura Davies of England shared fourth at 276 with Becky Morgan of Wales. Both shot 70s.
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