The head of the conflict-wracked country's National Transitional Council, Mustafa Abdel Jalil, said the ultimatum was offered to mark the three-day Eid al-Fitr feast following the end of the Muslim fasting month of Ramazan.

Talks are under way with civic and tribal leaders in a number of towns, including Qadhafi's birthplace Sirte, where he may be holed up, in an effort to avoid bloodshed, but more fighting could be imminent.

“From Saturday, if no peaceful solution is in sight on the ground, we will resort to military force,” Abdel Jalil said, warning that Qadhafi “is not finished yet.” Nato also said Qadhafi's influence remained potent despite him being on the run.

“He is displaying a capability to exercise some level of command and control,” Colonel Roland Lavoie, military spokesman of the Nato air mission in Libya, told a news briefing via video link from his headquarters in Naples.

While rebels sought to talk Qadhafi troops into surrendering in Sirte, their last major stronghold, Nato air strikes were now focused around the town.

“The pro-Qadhafi troops that we see are not in total disarray, they are retreating in an orderly fashion, conceding ground and going to the second-best position that they could hold to continue their warfare,” Lavoie added.

Rebel military spokesman Colonel Ahmed Omar Bani told a news conference in the eastern stronghold of Benghazi on Tuesday that his forces were “ready for a final military battle,” describing Saturday as “zero hour.” We have been given no indication of a peaceful surrender... We continue to seek a peaceful solution, but on Saturday we will use different methods against these criminals,” he said.

The capital Tripoli, meanwhile, launched Eid celebrations late Tuesday with bursts of red tracer rounds fired into the sky as a substitute for fireworks and people congregating in Martyr's Square, formerly known as Green Square.

“This is the first time we have felt relaxed in 42 years,” Amari Abdulla, 24, told AFP.

“We will celebrate as in the past but this time it is simply better. It is a new Libya.”

Italian news agency ANSA, citing “authoritative Libyan diplomatic sources,” reported on Monday that Qadhafi and his two sons - Saadi and Seif al-Islam - were hiding in Bani Walid, a town southeast of Tripoli.

The rebel military spokesman said Qadhafi's once feared intelligence chief, Abdullah al-Senussi, who is wanted by the International Criminal Court, may have been killed as he tried to reach Bani Walid.

Rebel fighters had destroyed two armoured vehicles on the road from the town of Tarhuna closer to the capital, and captured Qadhafi loyalists told them one of the passengers was Senussi, Bani said.

Libyan state television denied rebel claims that another of Qadhafi’s sons, Khamis, had been killed as he too tried to reach Bani Walid.

The rebels also renewed their calls for neighbouring Algeria to hand over Qadhafi's wife and three more of his children who fled over the border on Monday.

Algerian foreign ministry spokesman Amar Belani told AFP the decision to allow Qadhafi's wife Safiya, daughter Aisha and sons Mohammed and Hannibal to cross into the country was based solely on humanitarian concerns.

Just hours after crossing over, Aisha gave birth to a baby girl, a government official said, speaking on condition of anonymity.

“Aisha gave birth very early this morning. She had a little girl. Mother and daughter are doing fine.” The rebels' fledgling new administration meanwhile received a major boost to its finances with clearance from a UN sanctions committee for Britain to release dollar 1.6 billion in seized regime assets to pay for emergency relief.

Similar applications by Germany to release about one billion euros (dollar 1.4 billion) and France to unfreeze about five billion euros (dollar 7.2 billion) were also under consideration but being held up by Russia, diplomats said.

The NTC executive committee number two said Libya also expected to rehabilitate “a lot” of its oil wells in the “next few days” and downplayed the threat of sabotage by diehard Qadhafi loyalists.

“Qadhafi is on the run now and we now have a good idea where is,” Ali Tarhuni said without elaborating. “The threat is present but not too dangerous.”