The move means Baathists can rejoin the Iraqi army

Mr Bush called it an important step towards national reconciliation.

The Baath party, formed mainly from Iraq's Sunni minority, was declared illegal after the US-led invasion of the country in 2003.

The US had been urging Iraq's Shia-led government to approve the move in a bid to reach out to minority Sunni Arabs.

The new law will allow thousands of former party members to apply for reinstatement in the civil service and military.

"It's an important step toward reconciliation, it's an important sign that the leaders of that country understand that they must work together to meet the aspirations of the Iraqi people," said Mr Bush.

The president was speaking in Bahrain, the latest stage in a tour of the Middle East. Earlier, in Kuwait, he said hope was returning to Iraq.

"Iraq is now a different place from one year ago. We must do all we can to ensure that 2008 will bring even greater progress," Mr Bush said.

Reconciliation

Saddam Hussein's regime was predominantly Sunni and many figures were removed from government after his fall in 2003, under an edict from ex-US administrator Paul Bremer.

WHO ARE THE BAATHISTS? The party was the political instrument of Saddam Hussein's rule An estimated 2.5 million Iraqis were party members Banned and broken up by US administrator in May 2003 Baathism was a pan-Arab secular nationalist movement Error put right amid concerns Bush tour diary

The army was disbanded, thousands of teachers, university lecturers and civil servants were sacked.

The initiative, based on the de-Nazification of Germany after World War II, banned anyone who had been a member of the higher tiers of the party from government employment.

Some were reinstated after the US found that it had cleared out key ministries and the military without having any replacements.

After the Americans handed over power to an Iraqi government in 2004, they urged the Shia-led administration to ease the measures further in an effort to promote national reconciliation.

Much of the Sunni insurgency is thought to be centred on dismissed military men from the Baathist regime.

'Heavy blow'

The new legislation - called the Accountability and Justice Law - was approved on Saturday by all 143 lawmakers present in the 275-member house.

Saddam Hussein's Baath party was predominantly Sunni

It creates a three-month period for the ex-members to be challenged, after which they will be immune from prosecution over the Saddam era.

The law excludes former Baath members charged with crimes or still sought for them.

However, it will grant state pensions to many former Baathist employees even if they are not given new posts.

The BBC's Humphrey Hawksley in Baghdad says the legislation is seen as an attempt by the government to end the sectarian divide between the Shia and Sunni communities.

But almost five years on, after much bloodshed, it is unclear how many former Baathists will take up the offer to get their jobs back, our correspondent adds.

A spokeswoman for the US embassy in Baghdad told Reuters news agency that the new law showed "the political process is working in Iraq".

HAVE YOUR SAY Finally some common sense is surfacing after years of darkness Sal, NYC Send us your comments

Meanwhile, Mr Bush said there had been a dramatic improvement in the country since the US troop "surge" last year - when 30,000 extra soldiers were sent to the Baghdad area.

He added that US and Iraqi soldiers had dealt "heavy blows" to al-Qaeda, and that the country was "now a different place from one year ago".

He said the withdrawal of 20,000 troops by July was on track, but no decision had been taken to bring home more.