Ethiopia has warned Islamist militias who control most of southern Somalia that its patience is running out.
The situation in Somalia was going "from bad to worse", a statement from Ethiopia's foreign ministry warned.
The statement came as fighting between the militias and fighters loyal to Somalia's weak government continued for a fourth day.
Ethiopia denies its troops are backing government forces, but eyewitnesses report a sizeable Ethiopian presence.
Analysts fear the battles could escalate into full-scale war.
The Islamist militias - known as the Union of Islamic Courts - control the capital, Mogadishu, and have advanced towards the Ethiopian-backed transitional government's base in the town of Baidoa.
Clashes have been reported in Idale and Dinsoor, southwest of Baidoa, and Daynunay, east of the town.
"The situation in Somalia has turned from bad to worse. Ethiopia has been patient so far. There is a limit to this."
The BBC's 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 Union of Islamic Courts six months ago.
The International Red Cross has managed to get some information from the front lines and estimates that dozens are dead. At least 200 wounded fighters have managed to reach local hospitals, our analyst says.
Long-standing tensions
Somalia and Ethiopia - a mainly Christian nation - have a long 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 United Nations estimates that at least 8,000 Ethiopian troops may be in the country, while regional 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.
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