* China to reduce FX intervention when conditions ripe
* U.S. Treasury Secretary Lew say will be watching yuan in next few months
* Both sides agree to advance on bilateral investment deal by Dec (Adds remarks from U.S. Treasury Secretary, details)
By Kevin Yao and Lesley Wroughton
BEIJING, July 10 (Reuters) - U.S. and Chinese leaders have agreed that China will reduce its intervention in the currency market when conditions are ripe, reaching an understanding on a prickly issue that has hurt ties between the world's two biggest economies for years.
China's Central Bank Governor Zhou Xiaochuan said on the sidelines of annual high-level talks between the two nations that China will "significantly" reduce its yuan intervention when some prerequisites are met. He did not give further details.
Analysts said Zhou's unusual candour about China's currency intervention, which was echoed earlier on Wednesday by the Chinese finance minister, suggested that China may be ready to let the yuan rise again once its economy stabilises.
Indeed, U.S. Treasury Secretary Jack Lew told reporters at the end of talks on Thursday that China was committed to reducing its interference with the yuan, "as conditions permit". China will also increase the transparency of its currency policy, he said, describing the agreements as "major" changes.
"The direction of our reforms is clear: we hope that the exchange rate can be kept basically stable, at a reasonable and balanced level through reforms," Zhou said at a briefing on the sidelines of the two-day Strategic and Economic Dialogue.
"At the same time, we will allow market supply-and-demand to play a bigger role in determining the exchange rate, expand the floating range of the exchange rate, and increase the exchange rate's flexibility."
"This means that as the goals are being achieved and when conditions are ready, the central bank will significantly reduce its intervention in the foreign-exchange market."
The value of the yuan has long strained bilateral relations between China and the United States. In June, the International Monetary Fund judged the currency to be "moderately undervalued".
U.S. officials say China deliberately holds down its currency to boost its exports, an accusation China denies.
Instead, Chinese authorities weld their currency policy to the idea of stability, a stance that analysts say stems from China's fear of reliving Japan's experience in the 1980s, when a sharp rise in the yen hobbled the Japanese economy.
The yuan has fallen 2.4 percent so far this year as China's economic growth ground to an 18-month low in the first quarter. There are signs that activity is picking up again, though not as quickly as some had hoped.
"It feels like there was a fairly concrete discussion this time," said Louis Kuijs, an economist at RBS Bank in Hong Kong. "This is not just a repetition of the policy line that lay on the policy shelf.
"I think in the eyes of Beijing, once the concerns of economic growth are convincingly removed, there would be less resistance to letting the exchange rate appreciate."
WATCH THE NEXT FEW MONTHS
As had been the case in recent years, the yuan was a matter of contention at this year's Sino-U.S. talks. Lew told his counterparts from the start that a move to a market-determined exchange rate was a "crucial step" for China.
In response, Chinese Finance Minister Lou Jiwei said on Wednesday that Washington constantly raises the issue of whether Beijing can stop its yuan intervention. But Lou said it was difficult for China to be hands off given its unsteady economy and abnormal capital inflows.
Whether Thursday's agreement will be supported by action remains to be seen, a point noted by Lew who said he will be monitoring the renminbi's exchange rate in coming months.
"The experience of the next few months will tell us a lot about what the real impact is," he said.
Statements issued by both governments at the end of Thursday said policymakers on both sides agreed to avoid "competitive devaluation" of their currencies under a broader G20 deal.
The ninth-most traded currency in the world, the yuan is kept on a tight leash by China compared with its peers. The central bank sets a midpoint value every day, from which the yuan is allowed to rise or fall 2 percent in the spot market.
Before the yuan's retreat this year, China had denied it was intervening in the currency market. The central bank repeatedly said that it had ceased its interventions, and that the yuan was near its equilibrium level, even though traders said they still saw the central bank buying or selling the yuan on the market through state banks.
"China is sending a clearer message: it's unlikely for China to completely stop (yuan) intervention under the managed float regime," said Zhang Yongjun, a senior economist at China Centre for International Economic Exchange, a well-connected think tank in Beijing.
China's Central Bank Governor Zhou also signalled that it was not feasible for Chinese authorities to remain entirely on the sidelines of the foreign exchange market.
"If short-term market volatility or speculative forces are too big, we should take appropriate measures," he said in reference to gyrations in the foreign exchange market.
Apart from the yuan, the two sides agreed to try to wrap up talks on a bilateral investment treaty by the end of the year, and begin more contentious negotiations over a "negative list" of sectors that are off-limits to U.S. investment.
Washington wants to narrow the list to open up access to more areas of China's strictly controlled economy, a process it argues will help drive China's economic reforms.
China acceded as well to allowing U.S. firms that are being investigated by its anti-trust regulators to contest evidence presented against them by Chinese agencies.
The U.S. business community had pushed Washington to add China's antitrust regime to the agenda, as companies had privately voiced concerns that Beijing was using its anti-monopoly law to drive industrial policy. (Additional reporting by Michael Martina; Writing by Koh Gui Qing; Editing by Jacqueline Wong and Catherine Evans)