A Basra judge has issued an arrest warrant for two British soldiers after an Iraqi civilian was reportedly killed and a police officer injured.
Petrol bombs were thrown at British armoured vehicles on Monday
The two servicemen - believed to be undercover SAS officers - were detained after a confrontation on Monday.
UK troops later freed the soldiers from Iraqi custody after storming a police station in the southern Iraqi city.
Defence Secretary John Reid said no warrant had been received - and British personnel were immune from Iraqi laws.
"The MoD has not received any arrest warrant relating to any British personnel in Iraq," he said.
"Iraqi law is very clear: British forces remain subject to British jurisdiction.
"Even if such a warrant was issued, it would therefore be of no legal effect."
British forces spokesman Major Steve Melbourne said the two men had immunity from prosecution under an arrangement between the Iraqi government and coalition forces.
But he said the UK would "work closely" with the Iraqi investigation team, and with the Iraqi government.
"This has started and we'll see what comes from that into the events of Monday night."
Doubt over status
However, the judge said he was not convinced the two men were British and therefore would not be immune from arrest and possible prosecution in Iraq.
"We keep hearing that the arrest warrants are illegal. Well, until this moment we don't have any evidence that they are soldiers.
"According to the documents we have they are just foreigners," the judge said.
"We have asked for an official letter to tell us whether they were soldiers or civilians but we haven't received such a letter yet.
"Therefore the two men are still suspects and Iraqi law applies to them."
BBC correspondent Richard Galpin said that if the men were found guilty of deliberately killing an Iraqi civilian they could face life imprisonment.
It was widely believed that the soldiers on an intelligence mission in the city when they were challenged by Iraqi police officers, our correspondent said.
Iraqi police and the interior ministry say that the soldiers opened fire when challenged.
The BBC's Caroline Hawley said the issuing of the warrant indicated there was "a lot of local politicking going on".
"This judge knows that, certainly in some circles, what happened [on Monday] was extremely unpopular," she said.
News of the warrant follows a week in which authorities in Basra said they would not co-operate with UK troops.
Basra's governor, Mohammed al-Waili, said there would be no co-operation until there was an apology for the raid to free the soldiers.
The UK has defended its action, saying the soldiers were handed to militiamen by rogue elements in the police, but Interior Minister Baqir Solagh Jabr has denied this.
British troops have reduced their presence on the Iraqi city's streets.
On Wednesday, Iraqi Prime Minister Ibrahim Jaafari and Mr Reid said the unrest had not strained relations between the two countries.