First of all, the wool did not shrink. It has however changed shape and may or maynot ever be the same again.
Secondly, many people think it is the heat of the dryer that caused the damage. This is not true. When wool is dyed it is brought to near boiling temperatures, yet does not 'shrink' or felt at all.
So what does happen and why?
Take a look at these wool fibers up close. See the scales on them?
When wool is wet and agitated, these scales begin to connect together and interlock. The more they are agitated, the more tangled and locked they become until they are densely felted. Your sweater has an even great tendency to felt because heat and detergent cause the scales to open more readily. Plus the knit of the sweater gives the wool a 'head start' on the tangling process.
Can felting be 'un felted'.
I've never tried to unfelt something that is firmly felted, but since what has happened is a tangling and interlocking of the wool, some gentle tugging and maybe even a mist of fabric softner could help your unintentionally felted object. But a fully felted object is pretty permanantly changed.
Oh! And be careful with those needles! They are sharp!