The move came two days before the June 30 deadline for the handover. Word of the move came out of the in Turkey where, before the story broke, President Bush and British Prime Minister Tony Blair exchanged smiles and a handshake when they were tipped to the news.
Later, Mr. Bush declared that, "the Iraqi people have their country back."
Legal documents handing over sovereignty were handed over by U.S. governor L. Paul Bremer to interim Prime Minister Iyad Allawi.
"This is a historical day," Allawi said. "We feel we are capable of controlling the security situation."
Coalition sources say Bremer left Iraq immediately after the ceremony.
The surprise decision to suddenly move forward was driven by fear of possible widespread, coordinated attacks to disrupt the handover, reports CBS News Anchor Dan Rather.
As it was, the brief handover ceremony took place in virtual secrecy in the heavily guarded U.S.-led coalition headquarters, with very few people in attendance, no fanfare and no live broadcast — a reminder of the often desperate security situation on the ground.
Another reminder of persistent security woes was the threat by terrorists to behead a U.S. Marine and four other hostages from two other nations. A British soldier was killed in Basra, reports CBS News Correspondent Kimberly Dozier.
In other recent developments:
The early transfer had been under discussion between Allawi and U.S. officials for at least a week, a senior administration official said, speaking on condition of anonymity.
The handover ceremony took place in a formal room with Louis XIV furniture in an office in the building formerly used by the Iraqi Governing Council. Officials were seated in gilded chairs around a table, in the center of which was a bowl of flowers with a small Iraqi flag in it.
Just before the handover occurred, everyone stood up, and documents were passed to the chief justice at 10:26 a.m. local time — at that point, legal sovereignty was passed.
Bremer sat on the couch with President Ghazi al-Yawer.
"We'd like to express our thanks to the coalition," al-Yawer said. "There is no way to turn back now."
Although the interim government will have full sovereignty, it will operate under major restrictions - some of them imposed at the urging of the influential Shiite clergy - limiting the powers of an unelected administration.
For example, the interim government will only hold power seven months until, by a United Nations Security Council resolution there must be elections "in no case later than" Jan. 31.
The Americans will still hold responsibility for security. And the interim government will not be able to amend the Transitional Administrative Law, or the interim constitution. That document outlines many civil liberties guarantees that would make problematic a declaration of emergency — something Allawi has hinted he may try to order.
As Iraq's highest authority, Bremer had issued more than 100 orders and regulations.
Some are controversial. On Saturday, Bremer signed an edict that gave U.S. and other Western civilian contractors immunity from Iraqi law while performing their jobs in Iraq. The idea outrages many Iraqis who said the law allows foreigners to act with impunity even after the occupation.
Arab television broadcast videotape Sunday of two men taken hostage by terrorists, one described as a U.S. Marine lured from his base and the other a Pakistani driver for an American contractor. Insurgents threatened to behead them both.
U.S. Marine Corporal Wassef Ali Hassoun has been missing from his unit since June 21st, and his name is on a Marine "active duty" identification card shown by militants in the video aired by the Al-Jazeera network.
In the video, the hostage had a white blindfold covering his eyes. He wore military fatigues, and his mustache was trimmed.
Earlier Sunday, the Pakistani driver was shown on a tape broadcast by a different Arab television station, Al-Arabiya. The hostage displayed an identification card issued by the U.S. firm Kellogg, Brown & Root, a subsidiary of Halliburton.
Four masked men holding assault rifles across their chests said they will behead the Pakistani within three days unless Americans freed prisoners held at Abu Ghraib and three cities of central Iraq: Balad, Dujail and Samarra.
Also Sunday, Turkey rejected demands by terrorists threatening to behead three Turkish hostages unless Turkish companies cease business with U.S. forces in Iraq.