The official said President Mahmoud Ahmadinejad would give a speech later in the day "announcing that the heavy-water project has become operational".

Iran is building a heavy-water nuclear reactor at Arak, 120 miles (190 km) southwest of the capital Tehran. The plant's plutonium by-product could be used to make atomic warheads.

Western nations accuse Iran of seeking to master technology to produce nuclear weapons. Iran, the world's fourth largest oil exporter, insists its aim is only for electricity.

A small group of correspondents from foreign news organisations were being taken with Iranian journalists to Arak to attend the president's speech.

A senior Iranian nuclear official earlier this week said Iran would start up the heavy-water production part of the project but not the reactor. He had said this part of the project was not a proliferation risk.

"The product of this project provides for cooling and depleting systems of the reactor, that can be used in various industries," the official had told Reuters.

He said heavy water had no military use so supervision by the U.N. nuclear watchdog, the International Atomic Energy Agency (IAEA), was not obligatory.

One Western diplomat agreed that the heavy-water portion could not be diverted to military uses but said that such an announcement coming amid the current standoff over Iran's nuclear programme would not be a constructive step.

The West's main concern is Iran's programme for enriching uranium, a process that can be used to make fuel for nuclear power stations or material for bombs.

The U.N. Security Council has demand Iran stop this work by August 31 or face possible sanctions.

In its reply to an incentives offer backed by six world powers aimed at encouraging Iran to halt enrichment, Iran hinted it might be ready to consider halting the work as a result of talks but not as a precondition, which the package proposed.

The reply seemed tailored to divide the four Western powers and Russia and China who agreed to the deadline on August 31.

The United States has said the six powers will move quickly to adopt sanctions if Iran disregards the deadline. Britain, Germany and France have been less conclusive in public.

Russia and China, both trade partners of Iran, have been unwilling and could veto sanctions in the Security Council.