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BEIJING (Reuters) - Japan and China agreed to start formal talks early next year on a free trade pact that would also include South Korea, Japanese Prime Minister Yoshihiko Noda said on Sunday after talks that showed the deepening bonds between Asia's two biggest economies.
Japan also said it was looking to buy Chinese treasury debt, and the two governments agreed to enhance financial cooperation.
"On a free trade agreement among Japan, China and South Korea, we've made a substantial progress for an early start of negotiations," Noda told reporters after his meeting with Premier Wen Jiabao.
China's central bank, the People's Bank of China, said on its website (www.pbc.gov.cn) that the two leaders agreed to strengthen bilateral financial market cooperation and "encourage the use of the renminbi and Japanese yen in international trade transactions between the two countries."
The renminbi is another name for China's yuan currency.
The trade talks announcement builds on an agreement between the three countries last month also to seek a trilateral investment treaty and finish studies on the proposed free trade agreement by the end of December so that they could start formal negotiations on the trade pact.
"China is willing to closely coordinate with Japan to promote our two countries' monetary and financial development, and to accelerate progress of the China-Japan-Republic of Korea free-trade zone and East Asian financial cooperation," Wen told Noda at the meeting, according to Chinese Foreign Ministry's official website (www.mfa.gov.cn).
But the regional trade negotiations could also compete for attention with Washington's push for a Trans-Pacific Partnership (TPP), after Japan said last month it wants to join in the talks over the U.S. proposal.
Despite sometimes rancorous political ties between the two neighbors, Japan's economic fortunes are increasingly tied to China's economic growth and consumer demand.
China and Japan are also the world's first and second-biggest holders of foreign reserves. Wen told Noda that closer economic ties were in both countries' interests.
"The deep-seated consequences of the current international financial crisis continue to spread, and the complexity and severity of global and world developments have exceeded our expectations," Wen said.
"China and Japan both have the need and conditions to join hands more closely to respond to challenges and deepen mutually beneficial strategic relations."
China has been Japan's biggest trading partner since 2009.
In 2010, trade between the two nations grew by 22.3 percent compared to levels in 2009, reaching 26.5 trillion yen ($339.3 billion), according to the Japan External Trade Organization.
In a statement issued after the two leaders' meeting, the Japanese government said it would seek to buy Chinese government bonds -- a tentative step toward diversification of Tokyo's large foreign exchange reserves that are believed to be mostly held in dollars.
China central bank said the two governments agreed to support Japanese businesses issuing yuan bonds in Tokyo and other markets outside of China, and Japan Bank for International Cooperation would begin a pilot scheme for issuing yuan-denominated bonds in mainland China.
The People's Bank of China also said it will support Japan in using the yuan for direct investment in China.
But Japanese officials have stressed that Japan's trust in dollar assets remains unshaken, and the scale of the planned purchase of Chinese government bonds will be small.
Wen and Noda also agreed to set up a framework to discuss maritime issues after diplomatic ties deteriorated sharply last year following Japan's arrest of a Chinese fishing boat captain near disputed isles in the East China Sea.
Bilateral meetings attended by vice ministers and senior officials from relevant ministries will be held periodically to exchange views, in an effort to prevent a similar row from happening.
"On maritime matters, we have successfully set up a channel to solve problems through multi-layered dialogue," Noda told reporters.
Additional reporting by Koh Gui Qing; Writing by Chris Buckley; Editing by Yoko Nishikawa