The project had sparked a rare campaign of opposition, joined by Aung San Suu Kyi The project fuelled fighting between the army and ethnic Kachin rebels, and pro-democracy leader Aung San Suu Kyi recently joined the anti-dam campaign.
The suspension is being seen as a rare victory for social activists.
The BBC's South East Asia correspondent Rachel Harvey says it appears to be further evidence of the new leadership's desire to seek legitimacy by being more open to public opinion.
The army handed over power to a civilian authority in March, although many of the new rulers are ex-military.
Our correspondent says lobby groups will still be wary because Thein Sein has said he is suspending the dam's construction only for the term of his office, which ends in 2015.
Spectrum of opposition The Myitsone dam project was being developed jointly by Burma and China at the head of the Irrawaddy river in Burma's northern Kachin state.
Kachin rebels, who have been fighting government troops in a stop-start insurgency for years, were leading the opposition to the dam.
The dam, which was due for completion in 2019, would be one of the world's tallest at 152m (500ft) high.
The campaign against the project brought together conservationists, environmentalists, Kachin activists and the political opposition.
Their objections ranged from the lack of public consultation to the potential environmental impact of the project.
The dam would create a reservoir of some 766 sq km (300 sq miles) - about the size of Singapore - and displace thousands of ethnic Kachin villagers, our correspondent says.
"The president sent a message comprising 10 points to the parliament this morning. One of them said that the construction of the dam on the Irrawaddy will be shelved during the term of his government," one official at parliament was quoted by Reuters news agency as saying.
"He said that his government, being born out of people's desire, has to act according to the desire of the people," said the official, who declined to be named because he was not authorised to speak to the media.
The decision to suspend construction was unexpected.
Earlier this month, a report in the local Eleven journal said Electric Power Minister Zaw Min had declared that construction of the dam would proceed despite the objections.
The decision to halt construction was "a welcome surprise for everybody, inside and outside of Burma", Aung Zaw, editor of the Irrawaddy News website, based in northern Thailand, told the BBC.
The dam was to flood an area of rich biodiversity "It's the population, the whole Burmese who feel they belong to the culture heritage of the Irrawaddy river. They welcome the news."
Maung Maung Than, from the BBC's Burmese service, points out that the effect of damming the Irrawaddy - which flows from the north of Burma into the massive delta in the south - would have been felt throughout the country.
The vast majority of the power produced on the dam was to be exported to China, and correspondents say the dam had served to inflame growing anti-Chinese sentiment in Burma.
Beijing is investing vast sums in a series of big infrastructure projects aimed at exploiting Burma's rich natural resources and geographic position in the region.
There has as yet been no official reaction from China to the unusual step taken against it by its isolated ally.
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