Treasury officials were today in Iceland for urgent talks after the collapse of the country's banking sector left councils and charities in Britain facing losses of up to £1bn.
The crisis sparked a furious war of words between London and Reykjavik, with Prime Minister Gordon Brown denouncing the "totally unacceptable" failure of the Icelandic authorities to guarantee UK depositors would get their money back.
Icelandic Prime Minister Geir Haarde in turn blamed Britain for the collapse of his country's third largest bank, Kaupthing, after the Government used anti-terrorism laws to freeze Icelandic assets in the UK.
Downing Street confirmed that the Treasury delegation - which included officials from the Bank of England and the Financial Services Authority - was in Reykjavik.
Mr Brown's spokesman said they hoped now to work "constructively and cooperatively" with the Icelandic authorities. However he strongly defended the Government's action in freezing the Icelandic assets.
"The Prime Minister made clear, as is the case, that the behaviour of the Icelandic authorities had been unacceptable," he said.
"We had found it very difficult to get information from them. They had indicated that they would be giving preferential treatment to domestic creditors over overseas creditors."
Despite a another turbulent day on the markets, with the FTSE suffering more heavy losses, Mr Brown was carrying on with a visit to the South West, including a meeting with pensioners in Swindon, Wilts.
"Obviously he remains in minute-by-minute contact with Downing Street," the spokesman said.
The Government has promised individual savers with deposits in Icelandic accounts that it will reimburse any losses they suffer, but it has been resisting calls to extend the guarantee to local authorities and the charitable sector.
More than 100 councils, as well as police forces, fire services and transport authorities, have deposits running into millions of pounds each in the crisis-hit institutions.
Private companies are thought to have in excess of £10bn in Icelandic accounts they are unable to access. Charities, too, have tens of millions of pounds on the line.
Following talks yesterday between the Government and the Local Government Association, ministers said only that those councils facing the most severe difficulties would receive "appropriate" support.
City Minister Paul Myners will hold further talks with representatives of the charitable sector today.
LGA spokesman Ed Welsh said the losses were unlikely to cause immediate difficulties, as the money held in foreign banks was to earn interest rather than for current expenditure, but could have implications for the future.
"We are hopeful this will not have an impact on frontline services. In the long term, there may be an issue but it means deferring payment or tightening our belts," he told GMTV.
He defended local authorities' failure to withdraw their money from Icelandic banks sooner, arguing that no one could have predicted the crisis.
"Everyone has got this wrong, this is not just an issue about councils," he said.
"This is an enormous problem for many countries in the world, for most banks in the world. No one was keeping up to speed with it. No one could have predicted this a year ago.
"This is a problem that has been caused by Iceland. It is totally unacceptable behaviour," he said.
Last night, Mr Brown said he was determined to pursue the issue with the Icelandic government.
"I think we've got to be clear there is a responsibility on the Icelandic authorities to respond," he said.
"They are the regulators, they are the supervisors, they are the people responsible for what the Icelandic banks based in Iceland are doing, and we expect them to honour their obligations."
Mr Haarde, who spoke yesterday to Chancellor Alistair Darling by telephone, said Britain's use of the anti-terror laws to freeze the assets of Icelandic banks in the UK was a "completely unfriendly act".
"I told the Chancellor that we were not pleased with that, that they could not regard us in any way as the people that this Act is supposed to apply to - terrorists. I think he agreed," he said.