The UN Security Council has expressed "deep concern" at the escalation of fighting in Somalia and called on both sides to return to peace talks.
The transitional Somali government is backed by Ethiopia
It has called on the transitional government and the Islamic militia that controls most of southern Somalia to refrain from any hostile action.
The two sides have clashed for four days running near the town of Baidoa where the government is based.
The Red Cross estimates that dozens of people have been killed.
Ethiopia, which has never formally acknowledged sending troops to Baidoa, has demanded that the Union of Islamic Courts (UIC) militia stop its offensive there.
The Security Council on Friday called on the feuding parties "to draw back from conflict, recommit to dialogue... and refrain from any actions that could provoke or perpetuate violence and violations of human rights".
The call was echoed by UN Secretary General Kofi Annan, who said the escalation of conflict would "have disastrous consequences for civilians".
Analysts fear the fighting could escalate into full-scale war.
Islamist defence chief Sheikh Yusuf Mohamed Siad "Inda'ade" - who is regarded as a hardliner - urged foreign Muslims to join the "holy war" against Ethiopia.
"Our country is open to Muslims worldwide. Let them fight in Somalia," Reuters news agency quoted him as saying on Saturday.
On Friday Ethiopia had warned the UIC that the situation in Somalia had "turned from bad to worse" and that its patience was running out.
The UIC controls the capital, Mogadishu, and has advanced towards the Ethiopian-backed transitional government's base in the town of Baidoa.
Clashes have been reported in Idale and Dinsoor, south-west of Baidoa, and Daynunay, east of the town.
At least 200 wounded fighters have managed to reach local hospitals, our analyst says.
BBC regional analyst David Bamford says that if the claims by both sides about hundreds of dead are even partly true, it shows that the fighting has been the most serious in the country since the fall of Mogadishu to the UIC six months ago.
Ethiopia - a mainly Christian nation - and Ethiopia have a history of troubled relations, and Islamists have long called for a holy war against Ethiopian troops in Baidoa.
On Thursday a leader of the Union of Islamic Courts said they were in a state of war with Ethiopia.
Ethiopia denies its forces are battling the advancing Islamist militias, but admits to having some military trainers in Somalia.
A BBC correspondent reported seeing a huge convoy of Ethiopian military armour near Baidoa.
The UN estimates that at least 8,000 Ethiopian troops may be in the country, while rival Eritrea has deployed some 2,000 troops in support of the Islamic group.
Both the Islamist and interim government agreed to a ceasefire and to unconditional talks on Wednesday after a visit by EU envoy Louis Michel. He is believed to be working behind the scenes to end the fighting, the Associated Press news agency reports.
The UIC has introduced law and order to the capital and much of southern Somalia for the first time in 16 years. But other countries accuse it of links to al-Qaeda, charges it denies.