The peninsula, located southwest of the capital Reykjavik, is a seismic hotspot, with at least 40,000 earthquakes in recent weeks.
"Volcanic eruption has begun in Fagradalsfjall," the Icelandic Meteorological Office said in a tweet, referring to a mountain located about 30 kilometers southwest of the capital.
Pictures on local media websites showed a night sky glowing bright red.
All inbound and outgoing air traffic from Keflavik International Airport has been halted, the office told Reuters.
A helicopter with scientific personnel had been scrambled to assess the extent of the eruption, the office said.