Somali government fighters, backed up by Ethiopian troops, have attacked Islamist positions sparking heavy fighting, an Islamist leader says.
The Islamists called for all Somalis to fight Ethiopia
The clashes have occurred in Dinsoor, 110 kilometres (70 miles) south-west of government base Baidoa.
Islamist leader Sheik Sharif Sheik Ahmed called on all Somalis to "stand up and defeat the enemies".
The fighting come two days after the UN approved plans to send peacekeepers to Somalia - which the Islamists reject.
If the Ethiopian involvement is confirmed, it would be the first time that Islamist and Ethiopian troops have come into direct contact.
BBC Africa analyst Martin Plaut says the clash could be the opening shots of the long-anticipated war for control of Somalia.
Deputy Defence Minister Salat Ali Jelle confirmed the fighting to the BBC but denied that Ethiopian troops were involved.
The BBC's Mohammed Olad Hassan in the capital, Mogadishu, says local villagers report seeing Ethiopian troops.
He says telecommunications to Dinsoor have been cut off.
An Islamist commander in the area, Sheikh Mohamed Ibrahim Bilal, told the AFP news agency: "I don't have the exact toll, but I am told many people have died."
Mr Ahmed said the attack had been repelled.
"Our forces have been raided by Ethiopian troops, so people get up and fight against the Ethiopians," he said after Muslim Friday prayers in Mogadishu.
Ethiopia has denied repeated claims that its troops are fighting alongside government militia but admits to having hundreds of military trainers in Baidoa, the only town the government controls.
Meanwhile, the International Committee of the Red Cross has appealed to both sides to spare civilians, affected by devastating floods.
The ICRC says hundreds of thousands of people are on the move, trying to escape the flood waters.
The Union of Islamic Courts (UIC) has taken control of most of southern Somalia since taking Mogadishu in June.
On Thursday, UN Secretary General Kofi Annan said African nations who will contribute to the proposed force should persuade the UIC that it would not be an "invasion force".
"It is important that we get the Somalis to understand that the force is coming in to help," he said.
The resolution proposes sending an African protection force to Baidoa and easing an international arms embargo on Somalia to help the government re-arm.
The US-led resolution, adopted unanimously by the 15-nation Security Council, said the government represented "the only route to achieving peace and stability" in Somalia, which has been without effective central government since 1991.
The Islamists have also accused Ethiopia of shelling the town of Bandiradley, 630 kilometres (390 miles) north-east of the capital, Mogadishu, which is the most northern town they control.
One pro-government fighter was reportedly killed in the clashes.
Ethiopia and other states which border Somalia were excluded from contributing to the proposed African peace force.
Ethiopia has twice fought wars with Somalia.
Both government and Islamist forces have been preparing for war
Despite the exclusion of the "front-line states" the UIC still reject the idea of foreign peacekeepers, saying Islamic laws have already brought stability to areas they control.
"Deploying foreign forces to Somalia is seen as invading forces and the Somali people are prepared to defend themselves against aggression," Union of Islamic Courts official Ibrahim Adow told the BBC's Network Africa programme on Thursday.
However, observers believe it will be a long time before any peacekeepers arrive and say the UN resolution may be primarily intended to show symbolic support for the government.
The East African body, Igad, which is supposed to supply the troops is understood to be split over the idea.
Somalia's government has welcomed the resolution.
The government and the UIC are due to hold peace talks in Sudan next week.
The US, Ethiopia and the Somali government also fear the Islamists are offering shelter to al-Qaeda operatives, a charge they deny.
A recent UN report accused several countries, including Ethiopia and Eritrea, of breaking the weapons ban.