The US military has previously insisted on its right to patrol Najaf
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US forces have agreed to pull back from the holy cities of Najaf and Kufa to let Iraqi police take over control.
The move came after militiamen loyal to radical Shia Muslim cleric Moqtada Sadr, who have been fighting US forces for weeks, agreed to leave the area.
US commander Col Brad May said the military had agreed to move its forces to the edge of "these sensitive areas".
The Imam Ali Shrine in Najaf and the Kufa mosque are two of the holiest sites in the Shia branch of Islam.
Colonel May, commander of the US 2nd Armored Cavalry Regiment, told CNN there had been a "breakthrough" towards ending weeks of fighting.
"The US forces will pull back from the
sensitive areas... but we will still be in a position
where we can provide the necessary response force in the event
that the police should need it," he said.
The Governor of Najaf, Adnan Zurufi, said Mr Sadr's Mehdi Army militia had "been reduced to the point
where the legitimate Iraqi security forces can move in to
those very sensitive areas".
"It's an Iraqi solution to the
problem," he said. "All fighting forces, the coalition forces and the
Mehdi Army militia, should leave the two holy cities and
not allow any of their elements to enter again."
New government condemned
Mr Sadr did not mention the deal in a statement read on
Friday on his behalf in the Kufa mosque, where he routinely
preaches.
Instead, he condemned the newly appointed interim government of Iraq.
"America has taken upon itself to appoint a prime
minister and a president of the nation under the cover of
the United Nations," he said.
"It has
done that with impertinence and domination. The government
must be elected and I will never accept anything beneath
that."
On Thursday, Mr Sadr's spokesman, Qais al-Khazaali, told the BBC that militiamen who did not originally come from Najaf would begin leaving the area on Friday.
However, he added that residents of the city who supported Mr Sadr would stay and would not give up their arms.
His comments came after hours of talks between Shia negotiators.
Iraq's leading Shia authority, Ayatollah Ali Sistani, has cautious approval to the new Iraqi government that is due to take over at the end of the month - a boost to coalition attempts to increase stability in Iraq.