Ethiopian troops are approaching the Somali town of Baidoa, seat of Somalia's transitional government.
Islamist militia have advanced over the past few weeks
Ethiopia is the Somali government's main ally against the Islamic militia who control the capital, Mogadishu.
The Somali government has meanwhile declared support for an Eritrean rebel group, accusing Eritrea's government of supporting the Somali Islamists.
Regional rivals Ethiopia and Eritrea have both denied accusations that they are fighting a proxy war in Somalia.
Ethiopia has however said it would intervene if Baidoa came under attack.
The Ethiopian troops entered Somalia at the border town of Dolow about 0400 local time (0100 GMT) on Sunday, the BBC's Mohammed Olad Hassan says.
They were later seen with 11 armoured vehicles in the town of Awdinle, 30 km from Baidoa.
A spokesman for the Somali transitional government denied the presence of Ethiopian troops on Somali soil, and said the reports were Islamist propaganda.
In June, militia loyal to the Union of Islamic Courts took control of Mogadishu, which had been divided among rival warlords for 15 years.
In the past month the Islamist militia have moved northwards into central Somalia.
The transitional government, established in 2004, has not managed to extend its control beyond a relatively small area around Baidoa.
Controversy over proposed peace talks with the Islamic courts prompted a political crisis, with mass resignations from the government during July.
The courts have rejected calls for the deployment of a regional peacekeeping force in Somalia, and have refused peace talks with the government as long as Ethiopian troops are in Somalia.
In another development, the Somali government's special envoy to the European Union, Yusuf Mohamed Ismail, and foreign secretary of the rebel Eritrean Liberation Front, Yohannes Zeremaria, met in Geneva and pledged co-operation.
"They agreed that co-ordination between the democratic forces in the different countries of the Horn (has) become now an urgent obligation," according to an official Somali statement sent to AFP news agency.
The meeting follows allegations - denied by Asmara - that Eritrea is supplying arms to Islamic militia in Somalia.
Ethiopia and Eritrea fought a costly border war that ended in 2000, but tensions remain high as Ethiopian troops remain in the disputed town of Badme, which international arbitrators awarded to Eritrea.