* IMF says reasonable can take step to ease within 6 months
* IMF mission head says court ruling fostered stability
* Iceland seen returning to growth in H2 2010
(Adds detail, background)
By Niklas Pollard and Simon Johnson
STOCKHOLM, Oct 4 (Reuters) - Iceland should be able to loosen its still-tight capital controls within six months following a court ruling that left the financial sector on safer ground, the International Monetary Fund (IMF) said on Monday.
"The conditions have been falling into place for another step towards capital control liberalisation.," Mark Flanagan, IMF mission chief to Iceland, told a conference call. "The binding constraint right now is financial system stability."
Iceland's top court ruled last month that banks should use domestic interest rates when calculating charges on foreign currency loans, easing worries that a new wave of losses would hit the country's shattered banking sector.
Flanagan said the ruling removed much uncertainty overhanging the financial system. Although banks' balance sheets needed further restructuring, it set the stage for an easing of the capital controls put in place to prop up the currency.
"Overall, I think there are reasonable prospects for a step to be taken ... within six months," he said.
Capital controls were imposed after Iceland's three biggest banks collapsed during the global financial crisis in 2008 to prevent foreign investors from selling more local currency bonds and exacerbating a fall in the Icelandic crown.
The country has since kept the bulk of its capital account flows closed, but has allowed investors to move proceeds from investments overseas and has eased restrictions on trade flows.
GROWTH IN SIGHT
Iceland won approval late last month for further loans from the IMF under an international programme, opening the way for funding from its Nordic neighbours and Poland.
The North Atlantic island nation was forced to seek billions of dollars of aid from the IMF and its European neighbours as its banks faltered two years ago under a mountain of debt built up during years of aggressive overseas expansion.
The international lender said in its staff appraisal of the programme to the crisis-hit country that Iceland was expected to return to quarter-on-quarter growth during the second half of 2010 while a stronger currency was seen holding back inflation.
Iceland's gross domestic product contracted a seasonally adjusted 3.1 percent in the second quarter from the first as the after-effects of the banking collapse continued to ripple through the economy.
The IMF staff said much uncertainty still surrounded growth prospects due to large private debt, barriers to energy investments and an uncertain global economy, while pointing to the risk that excessive wage agreements could fuel inflation.
"It will be important for the authorities to reach a consensus with their social partners on wage settlements in the period ahead, and on a growth strategy to support investment," the staff report said.
The IMF staff also said Iceland should continue efforts to normalise relations with international creditors to unlock financing and restore confidence in international markets.
Britain and the Netherlands want Reykjavik to return money paid to depositors whose funds were frozen in so-called "Icesave" accounts operated by Landsbanki, which collapsed along with Iceland's other main commercial banks in 2008. (Editing by Stephen Nisbet)