Iraqi interim Prime Minister Ayad Allawi issued a "final call" Thursday to Shiite militants in the holy city of Najaf to disarm and vacate the revered Imam Ali Shrine.
Radical Shiite cleric Muqtada al-Sadr had said on Wednesday that he would accept a cease-fire deal, but insisted that coalition forces stop their operations first.
The Iraqi interim government then demanded he order his fighters to lay down their arms and publicly denounce violence.
Haidar al-Tourfi, an official at al-Sadr office's office in Najaf, said he received a text message from al-Sadr rejecting the demands.
"Either martyrdom or victory," the message said, according to al-Tourfi.
The violent clashes that have wracked the Shiite holy city of Najaf for weeks persisted Thursday, with explosions and gunfire ringing through the streets and black smoke rising over the center of the city. Shiite militants bombarded a police station with mortars, killing seven policemen and wounding 31 people.
Though government ministers have threatened a possible offensive against al-Sadr's militants in Najaf in the coming hours, Allawi set no deadline, saying only "we need to have a solution soon."
In other developments:
The ultimatum may signal a crossroads in al-Sadr's persistent challenge to U.S. forces and the interim government, which began violently in April, was suspended under a truce that allowed his al-Mahdi army to remain intact, then reignited in early August.
Analysts say al-Sadr has little support among mainstream members of Iraq's Shiite hierarchy but has become a symbol of resistance in the Shiite slums of Baghdad, Najaf and other southern Iraqi cities.
Explosions and gunfire could be heard Thursday in the streets of Najaf, where al-Sadr's militants have been fighting a combined U.S.-Iraqi force for two weeks. Three U.S. tanks and two Humvees were parked about 400 yards from the shrine, about as close as U.S. forces have come to the holy site during the fighting.
Fighters from the Mahdi Army militia could be seen manning positions in narrow alleys of the Old City and outside the shrine compound. A clock on the compound's outer wall, reportedly hit by shrapnel, was smoldering.
The mortar barrage that slammed into a police station in the center of the city on wounded 31 in addition to the seven killed.
The hospital was overflowing with the injured, some of whom were forced to sit on the floor as others lined the halls. Blood pooled on the floor and moans of pain echoed in the corridors.
The cease-fire deal aimed to end two weeks of fighting between al-Sadr's forces and U.S. and Iraqi troops in this holy city. The U.S. military says the clashes have killed hundreds of militants, though the militants deny that. Eight U.S. soldiers and at least 40 Iraqi police have been killed as well.
On Wednesday afternoon, Iraqi Defense Minister Hazem Shaalan said the government could send Iraqi forces to raid the shrine in Najaf by the end of the day. Prime Minister Ayad Allawi issued a statement accusing the militants of mining the area around the shrine.
Later Wednesday al-Sadr sent a letter to Iraq's national conference gathering saying he would accept its peace plan to put down his arms, withdraw from the shrine and turn to politics in exchange for amnesty for his fighters. However, he wanted an end to the fighting before he complied and he wanted to negotiate how the plan would be implemented, his aides said.
The government then added new conditions and warns it is ready to launch a military strike on the site despite fears any attack would outrage the Muslim world, reports CBS News Correspondent Elaine Cobbe.
Dawoud said al Sadr must immediately disarm his Mahdi Army militia and hand over its weapons to the authorities. The cleric must also give the government a signed statement that he will not practice acts of violence in the future and will release all civilians and Iraqi security forces that his militants have kidnapped.
In addition, al-Sadr must hold a news conference to announce that he is disbanding the Mahdi Army.