The Swedish krona is the talk of the town on financial markets as currency experts say it will gain a lot of ground against the euro.

On the currency markets, the focus has recently shifted to interest rate differences. In short term, the interest rate difference between two countries is an important driver of the exchange rate between them. The rule of thumb is: the higher the interest rate in one country, the more appealing its currency will be. Furthermore, it is not only the current difference that is important but much more the expected difference in the near future.

This has been very supportive of the krona and analysts expect that support will increase in the coming months.

When deciding which currency to buy, analysts look for central banks that are likely to lead the pack when in comes to interest rate hikes. Last month, the Norwegian central bank became the first European central bank to hike its key interest rate. Many economists expect the Swedish Riksbank will start doing the same sooner than the ECB and be more forceful at it than its counterpart from the euro area.

Currently, the key interest rate of the Riksbank stands at 0,25 percent. In the euro area it stands at 1 percent. It is expected that the Riksbank will start hiking its rate in the first moths of 2010, eventually bringing it at 1 percent in September next year. The contrast with the expectations for the ECB could not be larger. That central bank will most likely keep its rate on hold. Even if it hikes it, it will be one step of 0,25 percent. The upshot is: the rate difference between the euro area and Sweden will most likely entirely disappear next year.

For currency specialists at international banks such as Goldman Sachs, BNP Paribas, UBS and the Deutsche Bank that has been enough reason to expect the krona to strengthen in the coming months. Currently, the Swedes must fork over 10,3 krona for one euro. Expectations are that that will fall to 9,6 krona of even less for 1 euro in the second part of 2010. The krona seems to be on its way back to the long term average against the euro, at the exchange rate of 9,5 to 1.

There is one word of caution though and that word is ‘Latvia’. Earlier this year, the krona lost a lot of ground because of the worries that Latvia might be forced to devalue its currency. That would have caused large losses at Swedish banks, such as SEB and Swedbank, which was a very negative factor for the krona.

However, a couple of months ago, the Latvian government received a rescue package worth 7,5 billion euro (almost 80 billion kronor) from the European Union and the International Monetary Funds. The bailout of Latvia has staved off fears of a Latvian devaluation and has highly benefited the krona. It won a couple of percent against the euro. But now there are fears that the rescue package might not be enough and that Latvia will be forced to devalue its currency in the summer of 2010.

If the chance of that happening increase in the coming months, the doom scenario for Swedish banks, and hence the krona, will be back on the radar screen of every currency trader. In that case the krona might not be able to proclaim victory just yet.

Edin Mujagic is a Netherlands-based journalist and macro-economy expert.