Interim Prime Minister Ayad Allawi issued a "final call" on Thursday for Shiite cleric Moqtada Sadr to end his rebellion by agreeing to a new set of conditions issued by the government or face a military assault by U.S. and Iraqi forces, but Sadr signaled that he would not accept a key government demand.

Late Thursday night Sadr's office issued an unsigned letter that aides said was written by the cleric and bore his seal. The letter called on his followers "to hand over the keys" of the Imam Ali shrine in Najaf to Shiite religious leaders "as fast as possible so we will prevent infidels from entering this holy place."

But the letter rejected the other central demand of the Iraqi government: the disillusion of Sadr's Mahdi Army militia, saying it is a volunteer organization that belongs to Imam Mahdi, the Shiite messiah. "Let everyone know that this army is the Imam Mahdi's base and I have no right to ever disband it," the letter said.

Sadr's spokesmen during the past two days have provided sometimes conflicting responses -- at times positive, at times bellicose -- about the cleric's willingness to cooperate in defusing the crisis in the holy city of Najaf.

Allawi's statement was the latest chapter in an increasingly complicated arms-length exchange aimed at preventing a violent showdown at the sacred shrine of Imam Ali in Najaf, where Sadr's militia is holed up. The shrine is considered holy to Muslims across the globe.

While Allawi said "the door is still open" for Sadr's compliance with the government's conditions, the prime minister's comments were followed by declarations from his ministers that they were ready for an armed confrontation with Sadr's forces.

U.S. forces have cordoned off the shrine and are responding to attacks from Sadr's militia, but Allawi has told U.S. commanders he wants Iraqi forces, not foreign troops, to attack the shrine if necessary.

And while various officials of the interim government, as well as U.S. military officers, have repeatedly said they were on the brink of a major offensive in Najaf, none has occurred.

Meanwhile, the violence continued in Najaf Thursday with fighting between U.S. forces and Sadr's Mahdi Army in the vicinity of the shrine. The Reuters news agency reported that late in the evening U.S. aircraft pounded militia positions in the vast cemetery adjoining the shrine.

There was also a mortar attack by Sadr's insurgents on a Najaf police station that claimed at least seven lives, according to wire service reports.

In addition, supporters of Sadr in the southern city of Basra set offices and warehouses of Iraq's government controlled South Oil Co. on fire.

At the same time, U.S. forces were reportedly also moving through Sadr's stronghold suburb of Baghdad, Sadr City. A Mahdi Army spokesman said more than 50 combatants and civilians were killed in the fighting Thursday.

Also in Baghdad, a mortar hit the roof of the U.S. Embassy annex building, wounding two Americans employed by the embassy, a U.S. spokesman said. The building is the 258-room former Republican Palace used by deposed Iraqi leader Saddam Hussein and now houses offices for U.S. Ambassador John D. Negroponte and Gen. George W. Casey Jr., the senior U.S. officer in Iraq. It is within the heavily guarded Green Zone in the capital city.

Although the mortar pierced the roof, the building's solid construction may have helped contain the damage and injuries.

Insurgents have fired mortars toward the Green Zone on an almost daily basis for months, although most have missed significant targets.

As Iraqi officials seek to resolve the standoff in Najaf, they have used a two-pronged campaign. One has come from Allawi's government while the other has emanated from the national political conference, which concluded a four-day meeting in Baghdad on Wednesday.

Sadr's aides have responded more positively, albeit tentatively, to the national conference's initiatives and have rejected those of the government as illegitimate in an apparent effort to open up a gap. In their statements, they describe the interim government's officials as "so-called ministers."

The national conference, while part of the plan for Iraq's transition to democratic self-rule, is not an operating government body. It was convened originally to choose an interim representative assembly as a check and balance on Allawi's interim government.

Before it turned its attention to that task, however, it initiated negotiations with Sadr designed to head off a bloody showdown at one of Islam's holiest places.

Sadr had signaled Wednesday that he would accept a plea from Iraqi political leaders at the conference to dissolve his militia, vacate the shrine and join in the Iraqi political process but he asked for further negotiations with Iraq's interim government to work out details, according to a letter from Sadr's office that was delivered Wednesday.

Allawi, however, said he is not interested in negotiating but rather in compliance with the government's demands, which go somewhat beyond those of the political conference in that they require a surrender of weapons as well as abandonment of the shrine and dissolution of the militia.

Both Allawi and the Iraqi political conference emissary, Hussein Mohammed Hadi Sadr, stressed Thursday that they need to hear "personally" from Sadr. "I'm asking that he appear on the screen to say he is complying with the demands of the Iraqi national conference," said Hussein Sadr, who is a distant relative of the rebel cleric.

In a phone interview Thursday, Sadr spokesman Ahmed Shaibani, said Sadr would only deal with the conference representing the "opinion of the people" and not with the government.

In fact, Sadr has yet to personally meet with either. And while saying in a letter that he was willing to meet the conference's terms, including disbanding of his militia, he has not indicated when he would do so.

U.S. and Iraqi officials continued to express skepticism about whether Sadr would follow through, particularly with the pledge to disband his militia. Sadr has agreed several times in the past to peace deals with Iraqi officials, only to renege on them later.

"We're taking this with a big grain of salt," said a U.S. official familiar with the Sadr confrontation. "He's made a lot of promises before and he's broken all of them."

"I would be very cautious in accepting it as face value," said a senior diplomat from a nation with forces in Iraq. "A lot of people are scratching their heads and wondering whether the letter sent to the conference [by Sadr] meant anything and if so what it meant."

Even if Sadr disbands his militia, keeping its adherents disarmed is likely to be a long and complicated process. U.S. officials say many, if not most, members of the Mahdi Army are young men who joined up not out of religious fervor but because the militia offered them a job and a chance to vent their anger at the U.S. occupation. International experts on militias, including U.N. officials, have suggested that financial incentives might be needed to encourage compliance.

Barbash reported from Washington.