People near Najaf reported seeing orange flashes in the sky, followed by large clouds of smoke near the mosque where the Shia rebels are gathering.
The fighting died down at around dawn.
The bombing started after Iraq's Prime Minister Iyad Allawi gave the rebels a final warning.
Earlier this week Moqtada Sadr suggested the rebels would leave the shrine but they haven't.
The Imam Ali shrine is considered a special place for Muslims and the crisis is being seen as a big test for the new Iraqi government which came in at the end of June,