The British Government has behaved like a bully in its treatment of Iceland. First, when the country's banking crisis broke, it froze Icelandic assets in Britain using legislation that had been introduced to target the funds of terrorist groups. And then, when the Icelandic President ratified legislation last summer that would have seen the country compensate Britain for its losses, the Government effectively vetoed the plan, insisting it could not accept the various caveats that applied to Iceland's plans.

Since then, Britain has used every avenue possible to pressure Iceland. It is clear the government has used its influence within the European Union and at the International Monetary Fund to block aid packages that hold the key to Iceland escaping its ongoing economic crisis. Good old fashioned blackmail, one might call it.

During this week's row, the government has returned to the bully-boy tactics. Lord Myners, the City Minister, has characterised President Grimmson's decision to block a compensation deal as Iceland "effectively saying it did not want to be part of the international political system". That is a threat of isolation of the sort that Britain has more normally reserved for international pariahs such as Zimbabwe or North Korea.

This sort of behaviour does not become Britain. More to the point, it appears to have been utterly counter-productive. When Iceland's parliament voted to compensate Britain last summer, there were rumblings of discontent among its citizens, but widespread acceptance that the money would have to be paid. It was only when Britain insisted on a much more punitive package that the popular uprising against a deal began.

Until some sort of compromise is reached, Britain will get little or none of the money back that it had to pay out to compensate British savers. Iceland is even worse off. Its hopes of joining the EU cannot progress until this row has been resolved. IMF aid could be jeopardised.

For what purpose has this row been engineered? The Treasury is determined to be seen fighting Britain's corner in getting money back it is owed. No doubt there is also great embarrassment that these losses were ever incurred in the first place. Once Northern Rock collapsed in September 2007, British regulators should have realised that if an Icelandic bank followed suit, the country did not possess the funds to compensate savers. It was another 11 months before the crisis reached Iceland, a period during which its banks recruited hundreds of thousands of British savers.

In the end, no doubt, Iceland will find itself with little choice but to comply with international law and find some way to repay Britain. But all of this heartache could have been avoided had Britain taken preventative action before the crisis began. And the Government's embarrassment at failing to do so now seems to be fuelling the rage it is directing at a small and helpless European neighbour.