"After listening to opinions from all sides, I have decided to request a royal decree to dissolve Parliament," Yingluck said in a televised address.
"There will be new elections according to the democratic system," said the 46-year-old premier who came to power in 2011.
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"We should be proud of ourselves that this is the first time the people, owners of the country, reclaimed the country from a corrupt government with our bare hands. We do it today, my fellow Thais," Suthep said.
Yingluck, who protesters accuse of acting as a proxy for her fugitive brother and former premier Thaksin Shinwatra, was under pressure to quit and call a fresh poll since late last month, when protests started for her government to be replaced with an unelected "People's Council".
Election Commission member Sodsri Sattayatham said a general election to elect the 500-seat lower house will be held under Thai laws within 60 days, or before February 2, 2014.
However, protesters said their rallies will continue. Suthep said demonstrators would "blow the final whistle" in an attempt to uproot the "Thaksin influence" from the country and today's announcement was only the "first step".
Protesters besieged Government House this morning, prompting authorities to cancel a plan to invite foreign diplomats to observe the situation there.
Yingluck said she will remain the head of the interim government. "The situation seems likely to escalate to violence so the government has decided to return power to the people and let them decide through elections," she said.
However, protest leaders Satit Wongnongtaey and Tavorn Senieum demanded her resignation.
Satit told protesters that dissolution of parliament was only the first victory but it was not enough for achieving real democracy. He said the anti-government People's Democratic Reform Committee led by Suthep wants the "People's Council" to be formed and the caretaker cabinet to resign.
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