Members of al-Sadr's al-Mahdi Army will stay put in the embattled city until the occupation agrees to the initiative, said al-Sadr aide Qais al-Khazali on Thursday.
Earlier, al-Mahdi squad commanders said they were ordered to quit their posts in Najaf at noon. The bloody stand-off in the holy city has left hundreds of people dead in recent weeks.
Muwafaq al-Rabai, a member of the US-appointed Iraqi Governing Council, said late on Wednesday that al-Sadr made the offer in a letter to Najaf's Shia cleric hierarchy.
Al-Sadr offered to remove his fighters from Najaf but demanded that occupation forces "return to base" and allow Iraqi police to control the city, said al-Rabai.
For the first time in days there were no major clashes overnight.
As armed men began moving from positions, one squad
leader, Ali Abu Zahra, said he had formal instructions from al-Sadr to move his unit out: "It was a written and verbal order."
There was no immediate response from the occupation, who have dismissed past truces proposed by al-Sadr.
Al-Sadr denies US charges that
he killed a rival Shia leader
The weeks of fighting, which has spread to the nearby Shia cities of Karbala and Kufa, posed a major challenge to the US-led occupation struggling to gain control of the country ahead of a 30 June deadline to "transfer sovereignty" to Iraqis.
The agreement to abandon Najaf is a major step toward ending al-Sadr's resistance against the occupation. Some of the fighting has taken place near some of Islam's holiest sites and even left damage.
Shia cleric Shaikh Muhammad Mussawi said on Thursday that al-Sadr has agreed to a truce so that negotiations can get underway.
Al-Rabai's announcement came after US troops detained al-Sadr's key lieutenant, Riyad al-Nuri, in a pre-dawn raid on Wednesday.
The Shia leader also demanded "broad discussions" within the Shia community over the future of his army and that legal proceedings against him in a murder case of a rival Shia leader be deferred until then.
Al-Sadr said he is making this offer because of "the tragic condition" in Najaf after weeks of fighting between his men and the Americans and the damage suffered by the city's holiest shrine, the Imam Ali mosque.
Fighting around some of the holiest cities of Shia Islam has angered many Iraqis and people elsewhere.
The US insists that al-Sadr disband his "illegal militia" and submit to "justice before an Iraqi court".
In other developments, three US marines were killed in Anbar province, the military said on Thursday. No further details were released.