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* Statement falls short of a new ceasefire declaration
* Turkish PM reiterates that PKK must leave Turkey
* Conflict has hit the Turkish economy, killed thousands
By Ayla Jean Yackley
ISTANBUL, Feb 23 (Reuters) - The jailed leader of Turkey's Kurdish rebellion on Saturday signalled that his followers could release captives and further a fledgling peace process that may be the best hope in years of ending the decades-long conflict.
The call by Abdullah Ocalan, the head of the autonomy-seeking Kurdistan Workers Party (PKK), came after a rare meeting with members of parliament's only pro-Kurdish party at his prison on an island in the Sea of Marmara south of Istanbul.
It fell short of a new ceasefire declaration, which Prime Minister Tayyip Erdogan would like to see to boost an initiative that includes state officials' negotiations with Ocalan and aims to end a war that has claimed 40,000 lives since 1984.
Reading a short statement by Ocalan, Pervin Buldan, a member of the Peace and Democracy Party (BDP) who visited Ocalan with two other lawmakers, said upon their return that the rebel leader would like to see captives held by the PKK freed.
"A historic process is under way. All sides should be very careful and sensitive," Buldan cited Ocalan as saying.
"The state and the PKK both have prisoners. The PKK should treat prisoners well, and I hope they return to their families."
Ocalan may be referring to both captured soldiers and government employees kidnapped by the PKK in recent years.
Thousands of militants and their suspected supporters are in jail, many of them awaiting verdicts in trials that last years.
Turkey, the United States and the European Union list the PKK as a terrorist group.
REBELS' WITHDRAWAL SOUGHT
Earlier, Erdogan reiterated that the PKK must leave Turkey.
"We have repeatedly said weapons should be given up and members of this terrorist organisation withdraw from the country," Erdogan said at a news conference that was aired live.
"As for the withdrawal, we have said we will take measures to avoid the kind of unfortunate developments that occurred in the past," Erdogan said, possibly referring to military attacks on the PKK when they have declared ceasefires in the past.
The PKK says it keeps about half of its 7,000 fighters in Turkey and half in northern Iraq, where it maintains its main camps in remote, nearly impassable mountains.
Turkey estimates the number of rebels to be lower.
Erdogan has said he wants to end one of Europe's deadliest insurgencies. A sharp rise in violence since June 2011 has killed more than 800 soldiers and PKK guerrillas. Fighting has tapered off since October, as it does most years due to the weather.
The conflict has stunted economic growth, wrecked Turkey's human rights record and made EU membership elusive.
The war in neighbouring Syria, where Kurdish groups linked to the PKK were fighting opponents of President Bashar al-Assad, has given the peace process some urgency.
Buldan and the others' meeting with Ocalan was the second since January by the BDP, which Erdogan has called the "PKK's extension," and he also met his brother. Until recently, the 64-year-old rebel commander was kept in seclusion since June 2011.
Ocalan is serving a life sentence for treason. In jail since 1999, he still holds sway over the PKK and is considered a hero by nationalist Kurds. Ethnic Kurds make up about 20 percent of Turkey's population of 75 million people.
There are also large numbers of Kurds living in Iraq, Syria and Iran, and Kurds are frequently described as the world's largest ethnic group without its own state.
The PKK, which once sought an independent Kurdish homeland, has scaled back its demands to limited self-rule in Turkey's mainly Kurdish southeast and greater cultural rights. (Editing by Stephen Powell)