Iceland's central bank abandoned all attempts to shore up its battered currency last night as the country prepared to start loan talks with Russia and tried to quell a growing diplomatic row with Britain over savings deposits.

Geir Haarde, the Prime Minister, admitted that the country's economic recovery could take years.

Iceland, which has a population of only 300,000, had come to epitomise the global credit boom; now it is suffering the consequences after its banks over-expanded and speculators bet on its buoyant currency.

Yesterday Iceland abandoned its defence of the krona, one of the shortest currency pegs in history - it lasted a day - as it decided to break the currency's link with the euro. The central bank made a statement saying that it would no longer try to prop up the krona because there was “insufficient support” for the peg, which it had tried to hold to IKr131 to the euro.

The krona slumped to IKr151 after speculation grew that the bank would cut interest rates from the current record high of 15.5 per cent after the co-ordinated cuts yesterday by the US Federal Reserve, the European Central Bank and a handful of European and Asian countries.

Mr Haarde declined to comment yesterday on whether an Icelandic cut was imminent.

Iceland said that it would begin talks next Tuesday with Russia over an emergency €4 billion (£3.1billion) loan. Alexei Kudrin, the Russian Finance Minister, has said that Moscow views Iceland's approach positively, although the controversial loan is likely to be viewed poorly by Iceland's Western political allies.

When Mr Haarde was asked by foreign media why Iceland - a member of Nato - was in talks to borrow from the Russians, he replied that he had approached some other nations but had not received help.

However, Sweden said yesterday that would agree to lend Kaupthing Iceland's remaining private bank, SKr5billion (£408 million) to prop up its Swedish division.

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