NAJAF, Iraq, Aug 8: Iraq's Prime Minister Iyad Allawi ordered Shia fighters to lay down their weapons and leave the holy city of Najaf on Sunday, but fighting raged on with US helicopter gunships pounding guerilla positions.

While Allawi was talking tough during a surprise visit to Najaf, an Iranian diplomat was kidnapped in Kerbala by militants, according to the Iranian embassy, becoming the second foreign diplomat seized in a wave of kidnappings since April.

A video tape from a group calling itself The Islamic Army in Iraq - which was reported to have killed two Pakistani hostages last month - showed a bearded man, wearing a white shirt in front of a black banner bearing the group's name.

It also showed a passport and business card which identified the hostage as Iranian diplomat Fereidoun Jahani. "The group said in a statement it had kidnapped the Iranian consul in Kerbala because he had been involved in inciting sectarian strife and operating outside the sphere of diplomacy," the Dubai-based satellite channel Al Arabiya said on Sunday.

"The group also warned Iran against flagrant interference in the affairs of Iraq," the television added. During a brief tour of Najaf on Sunday, during which he was protected by scores of heavily armed US guards, Allawi urged militants to down their weapons or face the consequences.

"There is no negotiation with any militia that bears arms against Iraq and the Iraqi people," he told reporters in the shell-scarred city, 160km south of Baghdad. "I believe gunmen should leave the holy sites...quickly, lay down their weapons and return to the rule of order and law."

A Reuters witness on Sunday saw two Apache gunships fire missiles at defences manned by Sadr's militia near Najaf's ancient cemetery. The militia, known as the Mehdi Army, dug in, laying mines around the burial ground's crypts and mausoleums.

US soldiers advanced on the city's Imam Ali shrine, the holiest site in Shi'ite Islam, tightening a noose around insurgent positions, while loudspeakers exhorted the militia to fight back, ordering: "Engage in Jihad".

Clashes also erupted anew in the Baghdad slum district of Sadr City, and in other Baghdad areas, while across southern Iraq tensions remained high in several Shia-dominant cities, including Nassiriya, Amara, Basra and Diwaniya.

At least two mortar bombs hit a street near a Baghdad hotel used by foreigners on Sunday, wounding at least three people. An aide to Sadr rejected the prime minister's demand and said the Mehdi Army would never leave Najaf. -Reuters