* Iceland cuts key rate to 10 pct from 11 pct
* Second cut since receiving latest tranche of IMF bailout
(Adds background, analyst comment)
STOCKHOLM, Dec 10 (Reuters) - Iceland's central bank cut its key interest rate by one percentage point to 10 percent on Thursday as it looks to ease the pain of a sharp recession.
The central bank also cut rates by the same amount in November after keeping rates on hold since June seeking to protect its shaky currency, battered by the fallout from the collapse of its banking system.
"It's an indication that it's going better in Iceland so they can afford to lower the interest rate, but the bigger decision will be when they lift capital controls completely," Kent Bank Iversen, analyst at Jyske Bank said.
"Trade in the crown is still very much dependent on the capital controls."
Iceland suffered its sharpest ever contraction of gross domestic product (GDP) in the third quarter, shrinking 5.7 percent from the previous three month period.
The government's efforts to kickstart activity have been hampered by the tough conditions of a $10 billion plus bail-out package from the International Monetary Fund and Iceland's Nordic neighbours.
The country has also been embroiled in a spat with Britain and the Netherlands over paying back billions of dollars lost by overseas savers who had accounts with Icelandic banks at the time the island's financial system went under last year.
This has meant capital controls, imposed at the height of the crisis, remain in place, though there has been some easing.
In addition to the one-point reduction in the central bank's seven-day collateral lending rate, the Sedlabanki also lowered its overnight lending rate by 1.5 percentage points to 11.5 percent and cut its deposit rate by half a point to 8.5 percent.
The central bank will explain its decision at a briefing at 1100 GMT.
Reuters monitors offical statements on Iceland markets, companies and policy via the Internet from its Stockholm news room. (Reporting by Nick Vinocur; editing by Chris Pizzey)