The UN chief Ban Ki-moon says he is prepared to recommend sending some 27,000 peacekeepers to Somalia to replace the stretched African force.
About 2,400 African Union peacekeepers have deployed so far
But he said certain conditions had to be met including a ceasefire deal and the start of the withdrawal of troops from Ethiopia who back the government.
His comments come as the US added the Union of Islamic Courts' military wing to its list of terrorist organisations.
Ethiopia intervened to help oust the Islamists from power in December 2006.
Since then thousands have been killed in battles, mainly in the capital, Mogadishu, between Ethiopian-backed government troops and insurgents of al-Shabab, the UIC's military wing.
In the latest fighting, Ethiopian tanks and insurgents clashed in a cattle market in the north of the city.
Correspondents say the battle could be heard in districts across Mogadishu and an eyewitness in the area told the BBC that six bodies were seen, including three Ethiopian soldiers.
"Al-Shabab is a violent and brutal extremist group with a number of individuals affiliated with al-Qaeda," the US State Department said in a statement, AFP news agency reports.
"Many of its senior leaders are believed to have trained and fought with al-Qaeda in Afghanistan."
Al-Shabab becomes the 41st group to be added to the list of foreign terrorist organisations which allows the US to freeze the assets of any person connected to it.
Al-Shabab's Sheikh Muktar Robow told the BBC the group was honoured to be on the list, but rejected US accusations that members of the organisation are linked to al-Qaeda.
He said al-Shabab would continue to attack peacekeepers in Somalia
In a report to the UN Security Council, Mr Ban says the deployment of peacekeepers was one of four possible scenarios in which the UN might heighten its presence in the war-torn country.
An estimated 60% of Mogadishu residents have fled the city
The BBC's Tom Lane in New York says the other three scenarios envisage greater UN assistance in peace negotiations, and a huge reduction in violence would have to be achieved before troops could be sent in.
So far only 2,400 African Union peacekeepers have been sent to Somalia, of a planned 8,000-strong force.
"We must seize, without delay, the strategic moment, and move decisively to build the foundations for durable peace and stability in Somalia," the UN secretary general said in the report, AP news agency reports.
Last month, the UN warned that Somalia was the world's "forgotten crisis".
It estimates that 60% of Mogadishu's residents have been forced to flee the violence in the city over the last year.
The UN Security Council is due to discuss the report on Thursday.