The islanders are now free to return.

In a stunning turnaround the Foreign Office - after six hours of considering whether to appeal - caved in last night and began preparations to allow the islanders to go back.

The US state department had vehemently opposed resettlement, claiming it would create a security risk to their huge air base on Diego Garcia, one of the 65 islands that make up the Chagos archipelago, a British dependency. The US leases the island from Britain.

The Foreign Office, intent on ending an issue that has been a running sore, was last night working on a compromise that would see the islanders, most of whom were moved to Mauritius, return to two islands on the archipelago: Penhos Banhos and Salomon - but not Diego Garcia.

The Foreign Office still faces the prospect of hefty payments in compensation to the islanders. It is thought between 400 and 4,000 islanders might want to return.

Olivier Bancoult, who led the campaign on behalf of the islanders, insisted he was not interested merely in compensation but in going home: "We want to return to our motherland as quickly as possible," he said outside court yesterday.

The court awarded the islanders the costs.

Lord Justice Laws ruled that a British ordinance of 1971 used to evict the islanders had been an "abject legal failure". He said the British government at the time had claimed the ordinance was to make laws for "the peace, order and good government of the territory".

"I cannot see how the wholesale removal of a people from the land where they belong can be said to conduce to the territory's peace, order and good government," he said.

Hundreds of previously secret Foreign Office papers that emerged during the trial show the British and US governments cheated the islanders out of their homes with a colonial disdain more appropriate to the 19th century than the latter part of the 20th, and then lied about it in parliament and Congress for years.

One British diplomat referred in a memo to the islanders as "a few Tarzans or Men Fridays".

Mr Justice Gibbs said in the judgment: "It is clear from some of the disclosed documents that, in some quarters, official zeal in implementing those policies went beyond any proper limits. It would be no answer to say that these documents reflected the standards of a different period.

"I venture to think that the impression on right-thinking people upon reading them would have been similar then as now."

The court ruling was a potential embarrassment for the foreign secretary, Robin Cook, who in opposition had supported the islanders but in government found himself caught between the rights of the islanders and objections to their return from the US.

But Mr Cook escaped by pressing the US into accepting the compromise. He pointed out that Britain's treaty obligations covered only Diego Garcia and the US had no legal claim to the rest of the archipelago.

In a statement issued last night, he said: "I have decided to accept the court's ruling and the government will not be appealing."

He distanced himself from previous governments, Labour as well as Tory: "The government has not defended what was done or said 30 years ago. As Lord Justice Laws recognised, we made no attempt to conceal the gravity of what happened."

The Foreign Office ordered a feasibility study this year into whether the islands could practically sustain repopulation. The first stage suggested they could if new infrastructure was put in place.

For it to become habitable again, the islanders will need a new jetty, houses, a water purification scheme and some form of employment, either fishing or a resumption of the coconut trade. The biggest item will be a connection with the outside world.