AFP - Iceland's central bank on Wednesday cut its benchmark interest rate by half a percentage point to 9.0 percent amid signs that the Nordic country's battered economy was on the rebound.

"Supporting an interest rate cut is the appreciation of the krona ... despite the absence of central bank intervention in the FX (foreign exchange) market," the Sedlabanki said in a statement.

The bank, which had most recently lowered its main rate by 0.5 points on January 27, also slashed its other rates by 0.5 points Wednesday, with its deposit rate slipping to 7.5 percent, its maximum bid rate for 28-day certificates of deposit falling to 8.75 percent and its overnight lending rate dropping to 10.5 percent.

The next rate decision is expected on May 5.

The bank said Wednesday's rate-cut came despite a hike in inflation last month to 7.3 percent year-on-year, pointing out that "the pick-up in inflation was broadly anticipated."

And although "inflation is assumed to rise further year-on-year in March due to unfavourable base effects ... underlying inflation is still expected to reach the target late this year," the bank said, without specifying what the target was.

Before Iceland's economy crumbled as its major banks collapsed in October 2008, the country had an inflation target of 2.5 percent. No new target has since been set.

At the height of the crisis, as the value of the Icelandic krona crumbled, the Sedlabanki hiked its interest rate to 18 percent, making loans prohibitively expensive as many Icelanders lost their savings and jobs.

The bank said Wednesday it aimed to lighten capital controls, including restrictions on the purchase of foreign currencies, that have helped stabilise the krona, but said its hands were largely tied due to "significant uncertainty about Iceland's future access to international capital markets."

"We are taking a step by lowering the interest rates despite the uncertainty, but the step is small because of the uncertainty," central bank director Mar Gudmundsson told reporters.

"We are hoping that a situation will be created very soon allowing us to remove the capital control," he added.

Although the continued rate cuts hint that Iceland's economy is improving, the Nordic country is still struggling to get back on its feet.

On Tuesday, Iceland's finance ministry announced that the country's total treasury debt at the end of 2009 corresponded to 78 percent of its gross domestic product.

"Following the collapse of the banks, the total debt of the Treasury increased from 310 billion kronur (1.8 billion euros, 2.5 billion dollars) to 1,176 billion kronur at the end of 2009," the ministry said in a statement.

That figure did not however include the 3.9 billion euros (5.3 billion dollars) Reykjavik owes Britain and the Netherlands to compensate them for money they paid to 340,000 of their citizens hit by the collapse of the online Icesave bank in October 2008.

Icelanders resoundingly rejected a repayment deal in a March 6 referendum, but the Icelandic government has vowed to quickly negotiate a new and more favourable accord with London and The Hague.

Securing such a deal is widely regarded as a prerequisite for Reykjavik to access the remaining portions of a 2.1-billion-dollar International Monetary Fund rescue package, as well as a 1.8-billion-euro loan from its Nordic neighbours.

"We hope that this (Icesave) debate will be solved as soon as possible," Gudmundsson told AFP Wednesday, "or at least that the connection between Icesave and the IMF's second economic revision for Iceland will be disconnected"