Britain paved the way for a prompt compensation deal for Icesave depositors by offering to lend up to £100 million to one of Iceland’s crippled banks.

The loan, announced to parliament by Alistair Darling, Chancellor of the Exchequer, marks the beginning of the end of the fierce diplomatic spat with Iceland, the worst clash since the so-called Cod War of the 1970s. The anger of British Icesave depositors - fearing that they would be excluded from Icelandic compensation - stoked the conflict. Britain infuriated Iceland by using anti-terrorist legislation to seize the £4 billion of UK assets held by Landsbanki.

“The Bank of England is today providing a short-term secured loan of up to £100 million to Landsbanki, to help maximise the returns to UK creditors,” said Mr Darling.

The Icelanders were enthusiastic - they have been waiting for a sign of international confidence since the crisis began. The Reykjavik stock exchange has been closed since Thursday because of fears that the whole financial edifice could collapse. “This is a very encouraging step, “said a government source in Reykjavik.

The terms of the deal were worked out by Treasury and Bank of England officials during their weekend talks in the Icelandic capital. It will broadly follow the pattern of an arrangement with the Dutch authorities who have also been demanding protection for Dutch savers. Iceland said at the weekend that it would pay Dutch depositors £16,579 each, thus meeting its obligations under the country’s guarantee fund. The Dutch Government will announce a loan to help bankroll the compensation.

The claims are to be processed by the Dutch central bank.

The British situation is however more complex. The British loan seems to be only to Landsbanki - currently in receivership but functioning under the name of “New Landsbanki - which ran the Icesave online service.

But the nearly £1 billion of deposits, owned by British local councils and charities, were placed in other banks, notably Glitnir which is also in receivership. After the Treasury officials ended their visit to Iceland the talk was only of “significant progress.”

For Iceland, the loan is a breakthrough. A government delegation is heading for Moscow on Tuesday and there is talk in Reykjavik of a possible short-term Japanese loan. But Iceland was nervous that without a kind of peace with Britain, there would be no significant lending.

The International Monetary Fund last night denied that Iceland had officially requested financing from it, despite reports to the contrary.

The Icelanders are also waiting to see if British retail magnate Sir Philip Green takes on some of the huge debts of the floundering Baugur group which owns many British fashion outlets.

As Iceland casts around for new friends, age-old taboos are being broken. Having shunned the EU for half a century, in the last few days senior Cabinet figures have come out in favour of membership.

“It’s no secret, I’ve been against membership,” Einar Gudfinnsson, the Fisheries Minister, said yesterday. “However, the current turmoil means we have to look at every option.”

Ingibjorg Solrun Gisladottir, the Foreign Minister, went even further: “In the short term, our defence is co-operation with the International Monetary Fund, and in the long term EU membership, adoption of the euro and backup from the European Central Bank,” she wrote in the daily Morganbladid.

The rest of Iceland is also having to improvise. Estate agents, paralysed last week by the collapse of the banking system, are now offering snips — houses offered up by the banks in a fire-sale.

“Some people were smart enough to sell bonds before the crash,” said one estate agent, ”now they are sitting on piles of Icelandic crowns that they don’t want. So they’re putting some of it into bricks and mortar. Or rather: they’re thinking about it.”

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