Iceland's central bank raised its key interest rate by a quarter-point on Wednesday, taking its benchmark rate to 6.0 percent on a stronger growth outlook for next year, the bank said in a statement.
"The bank's macroeconomic forecast indicates that output growth in 2012 will be somewhat weaker than was projected in August. In 2013, however, it is expected to be stronger than previously forecast," it said in a statement.
It now expects growth of 2.5 percent in 2012, down from the previous estimate of 3.1 percent, but raised its outlook for next year to 2.9 percent from 2.2 percent.
Iceland's "accommodative monetary stance has supported the economic recovery in the recent term. The rise in interest rates since August 2011 and the decline in inflation have withdrawn a considerable amount of that accommodation," it said.
"As spare capacity disappears from the economy, it is necessary that monetary policy slack should disappear as well."
The rate of inflation has eased from 6.4 percent in April to 4.2 percent in October, but that remains far above the central bank's target of 2.5 percent.
In October 2008 the central bank rate shot up from 12 to 18 percent as Iceland's oversized financial sector and economy collapsed in the wake of the bankruptcy at US investment bank Lehman Brothers.
The rate then gradually declined to 4.25 percent by February 2011, but it has since been increased in six increments.
After suffering deep recessions in 2009 and 2010, Iceland posted growth of 2.1 percent last year, according to the national statistics agency.