(Updates with outcome of talks, fresh quotes)

By Jalil Hamid and Manny Mogato

KUALA LUMPUR/MANILA, July 27 (Reuters) - The Philippines' largest Muslim rebel group and the government agreed on Sunday to ballot areas within 12 months on whether they wanted to join an existing autonomous Muslim homeland in the volatile south.

The compromise came after the Moro Islamic Liberation Front (MILF) and the government resumed stalled talks in Malaysia.

While the deal was no guarantee that a final settlement to one of Southeast Asia's most intractable conflicts was in the offing, it was seen as an important step towards ending violence that has killed 120,000 people since the late 1960s.

"A breakthrough has been achieved in the issue of ancestral domain (homeland) in Kuala Lumpur tonight with the signing of a joint communique," said Hermogenes Esperon, the Philippine president's peace adviser, who attended the talks.

"With this positive development and the negotiations, the signing of the framework agreement on ancestral domain is tentatively set for early August," he said.

Under the deal, a referendum will be held in around 700 villages on whether they want to join the existing autonomous Muslim region.

Both sides had hoped to wrap up the talks last week in the Malaysian capital ahead of President Gloria Macapagal Arroyo's annual state of the nation address on Monday.

But the talks ended in deadlock on Friday after Manila tried to delay a referendum on enlarging the existing Muslim homeland until after a separate political agreement was reached.

OPPOSITION COMPLAINTS

The existing Muslim homeland has its own government, legislature and Muslim courts, but remains dependent on the central government for its budget, foreign, defence and monetary policy.

In the final political agreement still under negotiation, the rebels are pushing for the homeland to retain 75 percent of the taxes raised in that region.

A Malaysian government source close to the talks said the signing of the agreement on expanding the ancestral homeland would be held either on August 5 or 6.

Analysts say opposition among powerful Christian and Muslim families in the south and government hawks to a formal peace deal with the MILF, and Arroyo's reliance on their support, mean Manila's negotiating strategy could easily be thrown off course.

Real progress in the talks appeared to have been made when Arroyo last week supported postponing Aug. 11 elections in the Muslim south, because progress in talks with the 11,000-member MILF made a new political setup a possibility.

Some Manila lawmakers opposed postponement and complained that they did not know what had been agreed with the MILF. They complained Congress was not consulted on the issue. (Reporting by Manny Mogato in Manila and Jalil Hamid in Kuala Lumpur; Editing by Jon Boyle)

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