* U.S. says must let markets set exchange rates
* Rebalancing growth depends on market-set rates
* IMF needs to step up currency surveillance (Adds details, background)
By Glenn Somerville and Mark Felsenthal
WASHINGTON, Oct 5 (Reuters) - Letting currency exchange rates adjust in response to market conditions is critical for rebalancing global growth and will be on the agenda when finance chiefs meet on Friday and Saturday, a senior U.S. Treasury Department official said on Tuesday.
"It's vital to achieve more balanced global growth. That's why the United States has been working to address distortions in the pattern of global growth," the U.S. official said, adding that "market-oriented exchange rates (are included) in the set of policy tools that are vital to achieving that rebalancing."
This weekend's semi-annual meetings of the International Monetary Fund and World Bank take place against a background of heightening worry a round of competitive currency devaluations may be occurring with the potential to trigger a currency war.
The U.S. official, who briefed reporters on condition of anonymity, said repeatedly that the IMF needs to step up and take a stronger role in reviewing and speaking publicly about currency practices of individual countries.
"The IMF has to have an ability to speak forcefully and clearly in its surveillance of the major economies," the official said.
G7 MEETS FRIDAY NIGHT
Finance ministers and central bankers will gather for Saturday and Sunday's semiannual meetings of the IMF and World Bank. On Friday night, finance ministers from the Group of Seven wealthy nations hold a dinner where currency practices are likely to be up for discussion.
The G7 consists of the United States, Britain, France, Germany, Italy, Canada and Japan, so its membership includes many of the top economies, but not all of them since key emerging-market countries like China, Brazil and India are not part of it.
The U.S. official mentioned no countries by name, but stressed that those running trade surpluses need to live up to commitments made to assist in rebalancing growth.
"As America saves more, those countries that were overly reliant on exports to the United States in the run-up to the crisis will need to change their policies or else global growth will slow and all of us will be worse off," the official said.
China has run huge trade surpluses with the United States in recent years, drawing the ire of U.S. lawmakers who said Beijing's refusal to let its currency rise gave it an unfair advantage.
China agreed in June to let the yuan, also called the renminbi, react more freely to market forces. But since that time its value has only gone up about two percent, an indication that it remains in a tightly managed float.
Meanwhile, Japan has intervened in currency markets to drive its currency's value down and, on Monday, Brazil doubled a tax on foreign investors buying local bonds to 4 percent to curb a strong real that has risen because of a commodity boom and relatively high interest rates.
NEED COOPERATION, NOT UNILATERAL ACTION
The U.S. official, when asked about Japan, declined to comment on its market intervention directly but left little doubt that it was not seen as helpful.
"The United States has been very consistent in its position that the leading economies should be supporting exchange rates based on market fundamentals and we will consider to support that position," the official said.
"It's one that's been embraced by the G20 and we expect that countries will continue to move toward honoring their full set of commitments to the G20."
Demands that China let its yuan appreciate have become more intense because of rising volatility in currency markets and a widespread perception Beijing's current policy gives it unfair trade advantage.
Recently the U.S. House of Representatives passed legislation that would impose tariffs on Chinese imports if it does not allow more flexibility in currency exchange rates.
The U.S. official would not comment on China but noted the Obama administration has not taken a position on that legislative proposal.
The official said another item on the agenda would be ensuring that countries do not all simultaneously withdraw fiscal stimulus measures that helped buffer the global economy during the recent financial crisis.
"Our first priority has to be to strengthen the recovery and create jobs for our citizens and to do this we must be careful to avoid a premature synchronized exit that could threaten the global economic recovery," the official said. (Reporting by Glenn Somerville and Mark Felsenthal, Editing by Chizu Nomiyama)