Putting uranium hexafluoride (UF6) gas into centrifuges, which distill out enriched uranium, is a major escalation by Iran, and comes amid threats by the Islamic republic to withdraw from the nuclear Non-Proliferation Treaty (NPT).
The diplomat, who asked not to be named due to the sensitivity of the issue, said Iran had not yet fired up the whole 164-centrifuge cascade but had "over the past two or three days" started work with some centrifuges.
A second diplomat said Iran was doing "preliminary work" with "stand-alone" centrifuges, almost certainly putting uranium gas into single machines rather than a whole cascade.
The diplomat said this was necessary in a step-by-step approach involving first getting centrifuges running, then operating a pilot plant, which Iran has dubbed research work, and then moving on to industrial-scale enrichment with thousands of centrifuges.
Uranium enrichment is seen as a red line by the United States and European Union in the dispute over Iran's nuclear program, as it is crucial to making atomic weapons.
Iran strongly denies that it wants to make nuclear weapons, saying that its uranium interests are for strictly for peaceful civilian nuclear power.
Sanctions not a worry
The IAEA's 35-nation board of governors voted February 4 to report Iran to the UN Security Council where it could receive sanctions, but the IAEA left a one-month window for diplomacy.
Iranian President Mahmoud Ahmadinejad insisted that his country is not worried about possible sanctions, saying instead that the nations calling economic sanctions would lose far more than Tehran.
"I believe those who want to impose limitations on us will lose more than us," he told USA Today newspaper in an interview conducted Saturday.
Talks cancelled
Separately, talks with Russian officials in Moscow aimed at finding a compromise to the long-running international standoff will not go ahead as planned later this week, Iranian officials have had.
Russia however said talks could still be held.
Meanwhile French Prime Minister Dominique de Villepin has told a Russian newspaper that the international community was willing to negotiate with Iran on the nuclear crisis if the country took steps to end the standoff.
Annan urges more talks
UN Secretary General Kofi Annan urged Iran to help set the stage for a new round of talks on its nuclear program by March.
Secretary General Annan's appeal came after he met with US President George W Bush.
While President Bush was silent about the dispute with Iran, Secretary General Annan volunteered, "We need to be able to work to resolve it, and I hope there will be no steps taken to escalate the situation."