BAGHDAD ø Iraq's interim government blinked first in the showdown with the Iranian-backed Mahdi Army.

Iraqi officials said Prime Minister Iyad Alawi has agreed that the Mahdi Army could withdraw from the Imam Ali mosque compound in Najaf with its weapons. Alawi also dropped his demand for the Shi'ite insurgency movement to renounce violence.

The arrangement was meant to end a 17-day battle in Najaf by U.S. military forces against the Mahdi Army. Alawi ordered a halt to the U.S. military advance, which reached within 200 meters of the Imam Ali complex.

By Saturday, fighting resumed between U.S. troops and Shi'ite insurgents, Middle East Newsline reported. Both sides traded mortar, rocket-propelled grenade and machine gun fire, and officials reported the downing of a U.S. unmanned aerial vehicle. On early Sunday, U.S. warplanes bombed the old city of Najaf, but there were no reports of U.S. troops moving closer to the mosque.

The Iraqi government agreement called for the Mahdi Army, led by Moqtada Sadr, to withdraw from the mosque compound. The insurgents would then hand over the keys to aides of Grand Ayatollah Ali Sistani, regarded as the leading Shi'ite cleric in Iraq.

But the Mahdi Army failed to transfer authority to Sistani because it would not guarantee the departure of all of its fighters. Sistani's aides said they would not accept the keys to the mosque until the insurgents had left.

"We are continuing to do planning and preparations for continuous offensive operations to get Mahdi militia destroyed, to capture Moqtada Sadr and to turn the holy shrine back to the Iraqi people," Lt. Col. Myles Miyamasu, of the U.S. Army's 1st Cavalry Division, said.

The agreement between the Mahdi Army and the government on Aug. 20 fell short of Baghdad's demands. Alawi had called on the Mahdi Army to surrender its weapons and renounce violence. He also provided an ultimatum in which Iraqi forces would storm Mahdi strongholds.

But Alawi did not order any Iraqi attack in Najaf. The prime minister did not explain, but officials said several Iraqi commanders refused to order Shi'ite troops into battle.