UPDATE 1-Obama, Gaddafi shake hands at G8 dinner

(Adds background on U.S.-Libya relations)

L'AQUILA, Italy, July 9 (Reuters) - Libyan leader Muammar Gaddafi met his first U.S. president on Thursday, shaking hands with Barack Obama and sitting just one place away from him at a dinner for world leaders at a G8 summit in Italy.

The two leaders were photographed greeting each other and television images later showed Obama and Gaddafi -- who wore ruby red- and gold-flecked robes and hat -- separated only by Italian Prime Minister Silvio Berlusconi at the dinner table.

Strained for many years over Libyan support for groups Washington considers terrorist, U.S.-Libyan ties have thawed in recent years. But there is still mistrust on both sides and relations are businesslike at best.

The United States and Libya resumed diplomatic ties in 2004 after a break lasting more than two decades. The United States designated Libya a "state sponsor of terrorism" in 1979, and President Ronald Reagan ordered Libyan assets in the United States frozen in January 1986.

Relations sank further when the United States blamed Libya for the deadly bombing of a Berlin disco frequented by U.S. military personnel. U.S. aircraft bombed Tripoli, Benghazi and Gaddafi's home in April 1986, killing his adopted infant daughter.

Two years, later Libya was blamed for the bombing of Pan Am flight 103 over Scotland that killed 270 people. Libya eventually handed over two suspects to stand trial in the Netherlands.

In 2003, Libya reached a political agreement with the United States and Britain to accept responsibility for the Lockerbie bombing and agreed to pay about $2.7 billion in victims' compensation.

Later that year, Libya announced it was abandoning its weapons of mass destruction programs. President George W. Bush formally ended a U.S. trade embargo against Tripoli in 2004, and Libya declared an end to confrontation with the United States in 2008.