UPDATE 2-Microsoft reverses Windows 7 Starter limit

* Removes 3 application limit on most basic version

* Shows Microsoft looking to hold onto netbook market (Adds Microsoft blog quote, background)

SEATTLE, May 29 (Reuters) - Microsoft Corp (MSFT.O) said on Friday it would not limit the number of applications available at one time on the Starter edition of its upcoming Windows 7 operating system, reversing its earlier strategy of limiting its capabilities and urging users to upgrade.

The move is a significant climbdown for Microsoft as it looks to keep a hold on the fast-growing market for small, cheap personal computers -- known as netbooks -- which are the principal market for the most basic version of Microsoft's new operating system, expected to roll out later this year.

The world's largest software company had originally planned that users could run only three programs at one one time using Starter. The new plan would not limit the number of applications that could be used.

"We believe these changes will make Windows 7 Starter an even more attractive option for customers who want a small notebook PC for very basic tasks, like browsing the web, checking email and personal productivity," a Microsoft executive wrote in of the company's public blogs.

Microsoft acknowledged its plan to limit Starter's capabilities and then try to sell users upgrades, had not been well received by potential customers and partners, which are generally looking to increase the powers of netbooks rather than impose limitations.

Netbooks, or notebook PCs, have taken the computing world by storm in the last year or so, offering stripped-down functions on a small screen for only a few hundred dollars. Young users in particular have embraced them as an easy and cheap way to surf the Internet and send e-mails while on the move or at a cafe.

Microsoft noted that the Starter edition will still be inferior to its other, more expensive versions, designed for use on full PCs.

Windows 7 Starter will not allow use of more than one monitor, support Windows Media Center for watching recorded TV, or contain a number of other features. But Microsoft pointed out that its more advanced Windows 7 versions will also work on netbooks. (Reporting by Bill Rigby, editing by Matthew Lewis and Andre Grenon)