Corinne Diacre's France side are still through to the last eight as Group D winners, but missed the chance to go three wins from three in Rotherham on Monday.
Despite the loss of Marie-Antoinette Katoto to a knee injury, France seized a swift lead in the opening minute through Melvine Malard, with the PSG forward and Grace Geyoro also having goals disallowed.
That gave Iceland a modicum of hope to move into the last eight, but Dagny Brynjarsdottir's 102nd-minute penalty - after a lengthy VAR deliberation - proved to be too little, too late.
It was Belgium who advanced in Manchester thanks to a Tine De Caigny finish shortly after the interval, which sends them into the quarter-finals of a major tournament for the first time in their history.
They will make the short trip to Leigh, where they will face much-fancied Sweden on Friday, with France in Rotherham once again to do battle with the Netherlands on Saturday.
France were one of the stories of the opening round of fixtures, as they romped Italy 5-1 to get their tournament off to a brilliant start.
And they started their second game impressively too, going ahead after only six minutes when Kadidiatou Diani leaped highest at the back post to nod a Sakina Karchaoui cross into the back of the net.
However, the French were pegged back on 36 minutes with Belgium’s first shot of the match, when Janice Cayman poked a through ball from Tessa Wullaert past the oncoming Pauline Peyraud-Magnin.
Les Bleues had been completely dominant and did go into the break ahead, after Belgium failed to clear a corner. Clara Mateo whipped another delivery into the box, where Griedge Mbock Bathy was waiting to head home.
Corinne Diacre's team should have added a third heading into injury time, when a penalty was awarded for an Amber Tysiak handball. Tysiak received a second yellow card, but Wendie Renard's penalty was saved before she missed an open goal on the rebound.
Renard wasn't made to pay for her miss though, as France saw out the remaining minutes to clinch Group D and get them into the next round.
Italy and Iceland had never played each other at a Euros, and the former were desperate to put a humiliating 5-1 defeat to France in their tournament opener behind them.
Yet they found themselves behind just three minutes after kick-off, when a long throw into the box from Sveindis Jonsdottir wasn’t dealt with properly by the Italians. It sat up perfectly for Karolina Lea Vilhjalmsdottir, who rifled a half-volley into the top right corner to put Iceland 1-0 up.
Italy were arguably the better team in the remainder of the first half, but a number of good saves from Sandra Sigurdardottir maintained her side’s lead going into the interval.
That advantage would only last until the 62nd minute however. Barbara Bonansea came on at half-time, and it was her good work down the left-hand side that created the goal, as she drove to the byline before pulling the ball back for Valentina Bergamaschi. The Milan midfielder took it first time, and fired past Sigurdardottir to make it 1-1.
Bonansea herself hit the post on 73 minutes, when her dipping effort looked to be sneaking into the bottom corner until an important hand from Sigurdardottir tipped it onto the frame of the goal.
The two teams had chances to nick a winner late on, but neither could take them and they were forced to share the spoils as both still wait for their first win of the tournament.
Iceland sit second in Group D, while Italy remain bottom. Iceland will face France on Monday, knowing that a win will guarantee their place in the next stage of the competition. Italy and Belgium have one point each, and will both need to get a result before hoping France do them a favour if their competition is to continue.
Paris Saint-Germain midfielder Geyoro, winning her 50th cap, became the first player in tournament history to score three times before half-time, with Les Bleues' five goals heading into the interval also a record.
In an explosive performance that only solidifies their credentials as one of the pre-tournament favourites, France extended their winning run to 15 games across all competitions to go top of Group D after the first round of fixtures.
Geyoro's opener in the ninth minute set the tone for a superb first half at New York Stadium, with Marie-Antoinette Katoto doubling the lead three minutes later, before Delphine Cascarino sparked a madcap stretch before the interval that saw her team-mate grab her second and then third.
Matters looked to have gone from bad to worse for Italy after captain Sara Gama was shown a red card in the 66th minute for a high, mistimed tackle on Geyoro, but the VAR recommended a pitchside review, which controversially saw the decision downgraded to a booking.
That kept a full contingent of players on to help seize a late consolation goal through substitute Martina Piemonte, but Milena Bertolini's side now face a serious test of their character to see how they respond to such an emphatic drubbing.
Next, they play Iceland, who drew 1-1 with Belgium in Manchester as Justine Vanhaevermaet converted a spot-kick and Berglind Thorvaldsdottir missed one.
Thorvaldsdottir did get on the scoresheet five minutes after half-time, having earlier seen a tame penalty saved by Nicky Evrard, but Vanhaevermaet struck from 12 yards to secure a share of the spoils for the Red Flames.
