The eruption on Wednesday started near the mountain Fagradalsfjall on the Reykjanes peninsula south-west of Reykjavik, dpa news agency quoted the Icelandic Meteorological Office (IMO) as saying.
White smoke initially rose from the earth before glowing magma emerged, live images from the Icelandic broadcaster RUV showed, with lava spraying out of an extended crack in the Geldingadalur valley.
A leading vulcanologist said the fissure was several hundred metres long, in comments to RUV. It was not initially possible to estimate the scale the eruption will reach.
Local officials have implemented emergency plans, they said. Police advised people to avoid the area.
Several roads in the region were closed to traffic while emergency teams and scientists made their way to the site to assess the situation.
The Foreign Ministry tweeted that the risk to populated areas and critical infrastructure was considered very low. There has been no disruption to air traffic yet.
The area is relatively sparsely populated, but is home to the country’s most important airport, which handles practically almost all air traffic to and from the island.
The Blue Lagoon, a thermal spa popular with tourists, is also located on the Reykjanes peninsula, which is 30 kilometres from the capital.
The peninsula saw a similar eruption last year, when lava from the Krysuvik underground volcano system kept gushing out for about five months.
As then, the renewed eruption has been heralded in recent days by a series of earthquakes, some of them powerful, prompting scientists to warn that an eruption was likely.