Iran has started refining uranium deep inside a mountain, diplomatic sources said on Monday, a move likely to exacerbate a dispute with Western powers that suspect Tehran is seeking a nuclear weapons capability.

They said uranium enrichment to a fissile purity of 20 per cent had begun at the Fordow underground site near the Shi'ite Muslim holy city of Qom, signalling Iran's defiance in the face of intensifying Western pressure to curb such activity.

"Yes, they have," one Vienna-based diplomat said in response to a question on whether the operations had begun. 

Iran has said for months that it is preparing to move its highest-grade uranium refinement work to Fordow from its main enrichment plant at Natanz, and sharply boost capacity. Enriched uranium can have both civilian and military uses.

A decision by the Islamic Republic to conduct sensitive atomic activities at the underground site - offering better protection against any enemy attacks - could complicate diplomatic efforts to resolve the long-running row peacefully.

Iran's mission to the International Atomic Energy Agency, the Vienna-based U.N. nuclear watchdog, was not immediately available for comment.

On Sunday, an Iranian newspaper quoted the head of Iran's Atomic Energy Organisation as saying Iran would in the "near future" start enriching uranium at Fordow.

The US and its allies say Iran is trying to develop the means to make atomic bombs, but Tehran insists its nuclear programme is aimed at generating electricity and isotopes for medical treatment. – Reuters