Ethiopia has denied having any troops fighting in Somalia but admits sending hundreds of military trainers to help government forces.
The Islamists and government forces, allegedly backed by Ethiopia engaged in fierce clashes on Friday and Saturday.
There are fears of a regional conflict breaking out in Somalia, which could include Ethiopian and Eritrean forces.
"Starting today, if the Ethiopians don't leave our land within seven days, we will attack them and force them to leave our country," said Islamist defence chief Sheikh Yusuf Mohamed Siad "Inda'ade".
He also urged the international community to put pressure on Ethiopia to withdraw its troops or they would "be responsible for whatever happens in Somalia".
A UN report last month accused both Ethiopia and Eritrea, among other countries, of breaking the arms embargo on Somalia.
The Union of Islamic Courts (UIC) has taken control of much of southern Somalia, including the capital, Mogadishu, this year.
The government only controls the territory around the town of Baidoa.
Last week, the UN Security Council approved plans to send peacekeepers to protect the government in Baidoa and amend an arms embargo, despite strong opposition from the UIC.
On Monday, both sides said they were sending troops to Tiyeglow, on the main road from the Ethiopia border to Baidoa, following last week's clashes south-west of Baidoa.
"Our fighters, with large number of battle wagons, are now advancing on Tiyeglow," said UIC official Mohamed Ibrahim Bilaal.
"We will go to all border towns in our country to deprive our enemy [Ethiopia] of a route to enter into our country."
Government commander Mohamed Ali Gaboobe said they had sent some 700 troops to Tiyeglow on Sunday to prevent "Islamist expansion".
Correspondents say the military build-up makes it less likely that any peacekeepers will be deployed.
On Monday, Uganda, the only country which has publicly pledged to send troops, said the situation was now too risky.
The US, Ethiopia and the Somali government all accuse the UIC of working with al-Qaeda - an accusation they deny.
Some Islamists have talked about incorporating Somali-speaking parts of Ethiopia and Kenya into a "greater Somalia".
BBC News
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