Interim Prime Minister Ayad Allawi issued a "final call" on Thursday for Shiite Muslim cleric Moqtada Sadr to end his rebellion by agreeing to a new set of conditions issued by the government. Sadr responded by rejecting one of the government's two key demands, increasing the prospect of an intensified military attack against his militia.

The dramatic back-and-forth occurred as U.S. forces escalated their military operations in Najaf, dropping bombs and firing artillery to prepare for an assault on a sacred Shiite shrine that has been taken over by Sadr's militiamen.

Allawi said that "the door is still open" for Sadr's compliance, but warned that very little time remained for the cleric to abide by the government's demands that he dissolve his militia and vacate the shrine.

The interim prime minister's statements were the latest chapter in a tense, arm's-length exchange aimed at avoiding a violent showdown at the gold-domed Imam Ali shrine, one of the holiest sites for Shiite Muslims.

Sadr's office issued an unsigned letter on Thursday night 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 shrine 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 dissolution 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 refusal to disband his militia could trigger an all-out assault by U.S. and Iraqi forces against the Mahdi Army. Military officials have said such an operation would include efforts to flush militiamen out the mosque.

"We will categorically not allow armed militias," Allawi said at a news conference in Baghdad. "This is the final call to them to disarm."

Although Sadr's office sent a letter to a conference of Iraqi leaders Wednesday indicating that he would disband his militia and leave the shrine, Sadr and his aides took a far more bellicose tack on Thursday. One aide said Sadr, a mercurial 30-year-old, had instructed his deputies not to pursue talks with the government and to prepare instead for "martyrdom or victory."

The actions of Sadr's militiamen Thursday also prompted new concern among government officials about the cleric's sincerity in reaching a peaceful resolution. In Najaf, members of his Mahdi Army bombarded a police station with mortar rounds, killing seven policemen and injuring 31 others.

In Baghdad's Sadr City district, a Shiite slum, Mahdi Army militiamen engaged in several firefights with U.S. forces. In the port city of Basra, news services reported that militants loyal to Sadr broke into the headquarters of Iraq's state-run southern oil company and set warehouses and offices on fire after driving off security guards in a gun battle.

The Republican Palace in Baghdad's Green Zone, which now houses most of the U.S. Embassy's staff, was struck by a mortar round Thursday afternoon, wounding two Americans working for the embassy, an embassy spokesman said. The shell hit the roof of the building, which includes the office of U.S. Ambassador John D. Negroponte. It was not known who fired the mortars. Although mortars and rockets are routinely launched into the Green Zone, it is rare for them to be accurate enough to hit such a prominent target.

With a raid on the shrine and the surrounding neighborhood appearing increasingly likely, U.S. forces in Najaf stepped up efforts on Thursday to combat militiamen in other parts of the city. There were intense exchanges of fire as U.S. troops pushed into areas controlled by the militia. Bradley Fighting Vehicles advanced down streets firing bursts from M242 Bushmaster chain guns at 200 rounds per minute into buildings sheltering militiamen. After dark, an AC-130 Spectre gunship circled over the city, unleashing its 105mm howitzer with a repetitive gong that reverberated across the city.

The center of the city, which normally hosts tens of thousands of religious pilgrims each day, resembled the war zone it has been for two weeks. Buildings dating back hundreds of years have collapsed without being hit, brought down by blast waves. Three hotels, the Jeilawi, the Doha and Thul Fiqar, lay largely in rubble, destroyed by U.S. fire. In the late afternoon, clouds the color of concrete powder rose when a Marine Harrier jump jet dropped a pair of bombs on a target east of the shrine.

Allawi and U.S. commanders said the fighting was not the commencement of a final assault on the shrine but the continuation of a multi-day effort to prepare for the operation by targeting militiamen in neighborhoods near the shrine. "Shaping the battlefield," one Army commander said, describing the slow, armored nudge that left the 7th Cavalry Regiment in a rough semicircle around the shrine, with Army and Marines holding positions in the vast cemetery to the north.

Much of the most intense fighting overnight was not part of any offensive operations but cover fire for a convoy that had gotten mired in a dry lake bed west of the shrine. Two AC-130 gunships unleashed cannon fire and heavy machine-gun fire at Mahdi Army positions firing on troops.

With Sadr's aides and spokesmen offering conflicting statements about the cleric's willingness to defuse the crisis, Allawi said he wanted a clear statement from Sadr. "We would like for him to declare his intentions," Allawi said at the news conference. "What is his position? We only have heard from some people who work with him. We haven't heard from him directly. We would like to hear a final position before we move to the next phase."

But Allawi's government also has issued contradictory signals about its strategy. On Thursday morning, Allawi's minister of state, Qasim Dawood, visited Najaf and warned that Sadr faced an attack within hours if he and his followers did not vacate the shrine. Later in the day, the interim prime minister did not issue a deadline but suggested he would give Sadr some time to respond. "We need to have a solution soon," Allawi said.

On Monday, a national conference of Iraqi leaders called on Sadr to dissolve his militia, vacate the shrine and join in the Iraqi political process. The following day, the conference sent an eight-member delegation to Najaf to meet with the cleric, but he failed to see them. But on Wednesday, Sadr signaled he would accept the demands of the conference, and 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 to the conference.

Allawi has ruled out any negotiations. On Thursday morning, Dawood articulated the government's conditions to avert military action. They include demands to disband the militia and leave the shrine, but they also require the militiamen to surrender their weapons to government security forces, release people detained by the Mahdi Army and identify people who have been executed by the militia.

"The military action has become imminent," Dawood told reporters. "If these conditions are not met, then the military solution will prevail."

Government officials sought to play down differences between the government's demands and those of the conference, saying the thrust of both sets of conditions is the same and that the government's list provides less wiggle room for Sadr.

But Sadr's aides rejected the government demands. In a telephone interview Thursday, Sadr's spokesman, Ahmed Shaibani, said Sadr would deal only with the conference representing the "opinion of the people" and not with the government.

Like Allawi, the Iraqi political conference emissary, Hussein Mohammed Hadi Sadr, stressed Thursday the need to hear "personally" from Sadr. Earlier Thursday, U.S. and Iraqi officials had expressed skepticism about whether Sadr would follow through with the pledge to disband his militia.

"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."

Correspondent Karl Vick in Najaf contributed to this report.

A building explodes during a U.S. aerial assault in Najaf, where troops have escalated operations near the shrine of Imam Ali. A U.S. Army sniper keeps low in a fortified position in Najaf as clashes with cleric Moqtada Sadr's militiamen continued. Supporters of Moqtada Sadr rally at Najaf's Imam Ali shrine, which Sadr's militia has taken over. The Iraqi government has demanded that Sadr order the militiamen to vacate the mosque.