Social Democrat Johanna Sigurdardottir, 66, has been tipped to head the coalition, thus becoming Iceland's first woman prime minister.

One of Iceland's most experienced politicians, Sigmarsdottir served as minister of social affairs in the outgoing government and is known as a champion of social causes, earning her the nickname Saint Johanna.

Tough talks

The new government talks had stumbled on Friday after the centrist Progressive Party, which had pledged its informal backing to the new coalition in parliament, appeared to backtrack, reportedly saying key policy proposals were too vague and demanding more influence.

Sigmundur Gunnlaugsson, the leader of the Progressive Party, however told reporters late on Saturday that his party had agreed to offer the needed parliamentary support to the new coalition.

"The Progressive members of parliament have reached the conclusion that we will defend the government from a vote of no confidence," he said, stressing that his party would not commit to voting with the coalition on every issue.

The new government is unlikely to remain in place for long however, since the outgoing prime minister shortly before his resignation called snap elections for May 9.

Both the Social Democrats and the Left Greens have meanwhile decided to propose holding them earlier, on April 25, Sigfusson said.

Financial meltdown

Thousands have lost their savings and jobs since the once booming financial sector crumbled in October.

Iceland, a country of just 320,000 people, was one of the most prosperous members of the Organisation for Economic Co-operation and Development until the crisis.

In the past decade, Iceland posted average annual growth of four per cent, peaking at 7.7 per cent in 2004. In 2007, it registered growth of 4.9 per cent.

The Icelandic economy is expected to shrink by 9.6  per cent this year and see no growth in 2010. Unemployment, once almost unknown in Iceland, is expected to reach 7.8 per cent in 2009 and 8.6 per cent in 2010.

In November, Iceland became the first Western European country to be rescued by the International Monetary Fund since Britain in 1976, receiving a $2.1b loan from the international body.