"Ethiopian forces are on their way to Mogadishu. They are about 70 km (40 miles) away and it is possible they could capture it in the next 24 to 48 hours," Somalia's ambassador to Ethiopia Abdikarin Farah told reporters in Addis Ababa.
Islamists said any attempt to take Mogadishu would end in disaster for the attackers.
"It will be their destruction and doomsday," Islamist spokesman Abdi Kafi told Reuters. "It is a matter of time before we start striking at them from all directions".
Ethiopia backs Somalia's secular interim government against the Islamists who hold most of southern Somalia after seizing Mogadishu in June. Addis Ababa and Washington say the Islamists are backed by al Qaeda and by Ethiopia's enemy, Eritrea.
The Islamists claim broad popular support and say their main aim is to restore order to Somalia under sharia law after years of anarchy since the 1991 ouster of dictator Siad Barre.
A week of heavy artillery and mortar duels between Islamists and pro-government forces has spiralled into open war that both sides say has killed hundreds. Diplomats fear the fighting will draw in Eritrea on the side of the Islamists.
"What is happening in Somalia is very, very dangerous and will have consequences in the Horn," Eritrean Information Minister Ali Abdu told Reuters in Asmara.
Diplomats say Kenya was working behind the scenes to broker cease-fire talks between the warring sides.
At least two Ethiopian jets fired missiles on Islamist forces retreating from frontlines on Tuesday, prompting the government to claim a partial victory.
TOWN IN CHAOS
But the Islamists insisted their withdrawal and re-grouping was a tactic in what they vowed would be a long war.
"We will fight to the last man until we ensure there are no more Ethiopian troops in our country," Kafi said.
Thousands of Somali Islamist fighters crammed into camouflage-painted trucks mounted with anti-aircraft guns headed out from Mogadishu and elsewhere to reinforce comrades-in-arms beaten back from frontlines around the government base Baidoa.
The air-strikes at Leego and Jama'ada -- east of Buur Hakaba, a town recaptured by pro-government forces on Tuesday -- were the third day of air attacks by Ethiopian planes.
On Monday, Ethiopian fighter jets attacked two Islamist-held airfields, including one in the capital Mogadishu in a symbolic first strike on the movement's stronghold.
After the Islamist withdrawal, residents and local militiamen looted Buur Hakaba, 30 km (20 miles) east of Baidoa, stealing boxes of food and medicine, witnesses said.
"The town is in total chaos," said resident Adan Hassan.
Analysts say Ethiopia's heavy arms and MiG warplanes seemed to have halted an initial Islamist onslaught and saved the government from being routed in its south-central base Baidoa. "The Islamic Courts troops are retreating, some all the way to Mogadishu," government spokesman Abdirahman Dinari said by telephone from Baidoa. "This is the first stage of victory ... When this is all over, we will enter Mogadishu peacefully."
Despite hopes of a quick win, the government fears renewed assaults or a guerrilla campaign, particularly from hardliners within the Somalia Islamic Courts Council (SICC), Dinari said.
The government offered amnesty to any Islamists who lay down their guns. "The government will not take revenge," Dinari said.
Addis Ababa fears a hardline Muslim state on its doorstep and accuses the SICC of wanting to annex Ethiopia's ethnically Somali Ogaden region.
(Additional reporting by Sahal Abdulle in Mogadishu, Hassan Yare in Baidoa, Ibrahim Mohammed in Jowhar, Andrew Cawthorne and Bryson Hull in Nairobi and Jack Kimball in Asmara)
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