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UPDATE 2-Rio Tinto boosts cash returns as profit hits three-year high

(Adds CEO comments, details)

MELBOURNE, Feb 7 (Reuters) - Rio Tinto handed shareholders a record annual dividend on Wednesday as stronger commodity prices helped the global miner to its highest annual profit in three years, and pointed to strong momentum for the global economy.

Rio, which also announced an additional $1 billion share buyback, reported a 69 percent jump in underlying earnings for calendar 2017 to $8.63 billion, roughly in line with analyst estimates of $8.74 billion, according to Thomson Reuters I/B/E/S.

Its full-year dividend of $2.90 a share - equal to about $5.2 billion - was up 70 percent from last year and reflected a surge in cash flow as prices for iron ore, aluminium, copper and coking coal all improved on the previous year.

"All in all, we believe that we'll be able to generate a lot of cash this year," Chief Executive Jean-Sébastien Jacques told reporters on an earnings call.

"The strength of our balance sheet means we are ideally placed to deal with any economic volatility, invest in high value growth and retain the optionality for smart M&A," he added.

Rio, which more than halved its net debt to $3.8 billion, said higher commodity prices helped drive full-year revenues up 18.3 percent to $40 billion.

"It's pretty solid result," said portfolio manager Andy Forster at Argo Investments in Sydney.

"Dividends that are bigger than the market expected, and increased the buy back, an incremental $1 billion, that's pretty positive. The quality of their product has attracted a premium and they have done well on costs, though that is probably starting to get more challenging going forward."

CHINA DEMAND

Solid Chinese demand for commodities has been translating into handsome returns by big miners in the form of dividends and buybacks. Last year alone Rio's share buybacks totaled $4 billion, partly supported by the sale of some coal assets.

Iron ore, Rio's biggest income generator, contributed $6.69 billion in full-year underlying earnings, nearly 70 percent of the total. Average prices for the steel-making ingredient rose 20 percent last year from 2016, the miner said.

Rio Tinto has grabbed more market share in China as the country's steel makers turn to less polluting raw materials such as high grade iron ore amid a crackdown on pollution, and Jacques said the shift to high grade ore may be here to stay.

"I believe we could be close to a turning point in relation to a structural change in China which is very good for us," he said.

Australia's government has forecast a 20 percent fall in average iron prices this year on rising supply and moderating Chinese demand, but that is out of step with some private forecasts, such as UBS and Citi, which see smaller reductions.

Rio maintained its 2018 capital expenditure forecast at around $5.5 billion, while keeping its 2018 production guidance intact after raising its iron ore shipments target by 10 million tonnes last month.

Jacques acknowledged market volatility and short term risk in China, but reiterated the miner's confidence in the world's top commodities consumer while noting a revival in global manufacturing growth.

"China is the main customer in relation to the mining business (but) the GDP is pretty strong across all geographies today. Mining at the end of the day is a GDP-driven industry so today we are in a good space," he said. (Reporting by Melanie Burton; additional reporting by Rushil Dutta in Bengaluru; editing by Richard Pullin)