China has revalued its currency, the yuan, for the first time in a decade - a move welcomed by the US, a long-time critic of its exchange-rate policy.
Critics claim China has kept the yuan low to boost exports
The announcement on Thursday was widely seen as the first step towards the liberalisation of China's currency.
The yuan will no longer be pegged to the dollar, but will float against a basket of currencies.
It will also appreciate against the dollar, mollifying critics who say a cheap yuan has helped Chinese exports.
"I welcome China's announcement today that it is adopting a more flexible exchange rate regime," said US Treasury Secretary John Snow in a statement.
"As we have said, reform of China's currency regime is important for China and the international financial system."
Moving 'in tune'
Mr Snow said the US would watch China's implementation of its new system, which will see the yuan float against a basket of currencies, rather than linking it at a fixed rate to the US dollar.
China's currency had been pegged at 8.28 against the dollar, but the new move effectively strengthens it by 2.1%, to 8.11 to the dollar.
"The Chinese have now put in place a system to allow their currency to move in tune with the global economy," Mr Snow said.
Meanwhile the International Monetary Fund (IMF) said it was ready to "work with the authorities on the continuing evolution for the exchange rate system".
After the announcement the euro came under pressure from a rallying Japanese yen, which rallied sharply across the board - including against the US dollar.
Japanese officials welcomed the yuan's revaluation, saying it would benefit both the economies of China and Japan.
The dollar dropped against several Asian currencies following the Chinese announcement, sinking from 112.50 yen to 110.38 yen, its lowest level since 30 June.
Criticism had been strongest in the US, where many blame China for the decline of domestic industry.
However the White House also welcomed the move, with presidential spokesman Scott McClellan saying: "We are encouraged by China's announcement today that they are adopting a more flexible market-based currency system."
And Thomas C Dawson, director of external relations at the IMF said: "The change in China's exchange rate regime announced today represents a move in the direction of greater exchange rate flexibility.
THE CHINESE PEOPLE'S MONEY
People's Bank of China establishes the Renminbi, or people's money, in December 1948. The currency is more commonly called the yuan.
The yuan is fixed at 2.42 to the dollar from 1953 to 1972 - the height of China's Soviet-style planned economy.
China introduces a dual track currency system. The yuan is maintained for domestic use only, while foreigners are required to use foreign exchange certificates.
China adopts current account convertibility in 1996. The yuan trades in a narrow band of 8.28 to the dollar
July 2005: China announces a shake-up in the way it values its currency. It ditches the dollar peg in favour of a basket of currencies.
"Greater flexibility is very much in China's best interest, as it would provide more room for monetary independence, enhancing the government's ability to manage the economy.
"We would encourage the authorities to utilise fully the scope for flexibility in the new exchange rate arrangement."
In an announcement on state television, the Chinese government said that from Friday the yuan would be allowed to trade in a tight range of 0.3% against a basket of foreign currencies.
However, it did not indicate which currencies they would be.
In a move that seems to be coordinated with the Chinese decision, Malaysia has also scrapped its currency's link with the dollar.
The Malaysian ringgit had been pegged at 3.8 to the dollar since September 1998, in the aftermath of the Asian financial crisis.
Malaysia's central bank said it did not expect the currency to deviate widely from its current level against the dollar.
The Chinese revaluation came a day after US Federal Reserve chairman Alan Greenspan warned that China faced a "very serious" risk to its economy if it did not allow its currency to rise in value.
Senior US politicians had threatened to impose tariffs against China if it did not revalue the yuan.
However despite the warm reactions, some analysts reacted with some caution to Beijing's decision.
"This looks like a very minimalist move," said Mark Cliffe, an economist with ING. "It maybe relieves the pressure from the US with tariffs on the table in Congress but it remains to be seen if it is enough politically and economically."
The shake-up of the way the yuan is valued was "clearly more symbolic than anything else" said John Ip, a senior economist with Morley Fund Management.