The Iraqi kidnappers killed one of the four Italian hostages on Wednesday.
Visiting special UN envoy Lakhdar Brahimi also urged a peaceful settlement of the coalition's showdown with Sunni and Shia rebels, while Iran sent a fact-finding team to Iraq, apparently at the invitation of Britain.
Saudi Arabia's religious authority issued a fatwa, or religious edict, on Wednesday urging Muslims to use "all means" to stop what it called "the fierce onslaught" on Muslims by "occupation forces" in Iraq.
In the Sunni bastion of Fallujah, where US marines suspended major offensive operations on Friday, an AFP correspondent said US helicopter gunships strafed rebel positions and that loud explosions were heard.
An Iraqi mediator earlier said both sides had agreed to a 48-hour truce extension from 9:00 am (0500 GMT) on Wednesday to allow for two hospitals to reopen.
Hospital sources said that five Iraqis had been killed and three others wounded in clashes between US troops and insurgents in Fallujah despite the truce.
US forces suffered more casualties elsewhere, with four US marines reported killed in attacks over the last 48 hours in the al-Anbar province, which includes Fallujah.
More than 80 US soldiers and around 700 Iraqis have been killed in fighting in Iraq over the past nine days, mainly around Fallujah where marines launched a major crackdown last week following the brutal murder of four US contractors.
The Pentagon on Wednesday said 688 US soldiers had now been killed in Iraq since the invasion in March last year.
US forces were also massed on the outskirts of the holy city of Najaf, poised to go after firebrand Shia cleric Moqtada Sadr and eject his banned Mehdi Army.
Sadr is wanted for the alleged murder of a rival cleric last year, and US commanders have said their mission is to kill or capture him.
Local residents were seen stocking up on fuel and food as they braced for an expected assault.
But in a series of significant concessions, Sadr agreed to drop all his conditions in negotiations with the US-led coalition and to follow the guidance of the highest Shia religious authority.
"Moqtada Sadr is ready to accept what the Marjaiya ask for and to drop the conditions he had set for a mediation," a Sadr aide, Qais al-Khazaali, told a press conference in Najaf.
He said the Marjaiya had chosen a delegation to negotiate with the US side a settlement of the crisis.
A Sadr aide later said the radical cleric was willing to appear before a court in connection with the murder charges, but only under a future "legitimate and democratic" government in Iraq.
Sadr also said through a spokesman that he was ready to transform his Mehdi Army militia into a political and social organisation with no military activities.
Meanwhile, an Iranian foreign ministry delegation arrived in the capital to help settle a stand-off between the coalition and Sadr.
"We are going to meet with them, and they may meet with Sayyed Sadr," Haidar Aziz, a close aide and personal interpreter of Sadr, told AFP.
But the Iranian foreign ministry's director for Gulf affairs, Hossein Sadeghi denied that the delegation was involved in mediation.
"We are here to have a clear assessment of the situation to have a better understanding of what's going on in Iraq," he said.
Also on the diplomatic front, Brahimi said he was still confident a caretaker Iraqi government could be set up on time ahead of the June 30 hand-over of power.
He added that Iraq would have a truly "representative government" only after the elections scheduled next January, which he described as "the most important milestone."
"There is no substitute for the legitimacy that comes from free and fair elections," he added.
He also said that despite the worsening security situation in Iraq, the United Nations was "confident" a new caretaker government would be put in place ahead of the June 30 deadline.
"We are confident that it will be possible to form such a government in a timely manner, that is during the month of May 2004," he said.
One of the four Italian hostages being held in Iraq has been killed, the Arab satellite channel Al-Jazeera reported on Wednesday, quoting a communique sent to it by the kidnappers.
The channel also said it had received a "video film and photos showing the murder of the hostage" but said it could not broadcast the material for fear of upsetting its viewers.
The kidnappers of the four Italian civilians, who were working for a private firm, had demanded the withdrawal of Italian troops from the country in an earlier video message broadcast on Al-Jazeera.
Foreign nationals were urged to flee Iraq as anti-occupation insurgents stepped up a campaign of hostage-taking.
The latest to be snatched were two more Japanese nationals, including at least one journalist, a Japanese opposition MP said in Amman on Wednesday.
Yukihisa Fujita of the Democratic Party of Japan identified the pair as freelance journalist Junpei Yasuda and the other man simply by his family name Watanabe.
"The two were abducted in Abu Gharib. They were in a taxi on their way to (film) the helicopter which was shot down," he told AFP after a briefing on the latest abductions at the Japanese embassy.
Fears grew for three other Japanese hostages who have been under an execution threat since Monday afternoon. Japanese officials refused to comment on whether any progress had been made in securing their release.
Russia meanwhile announced it would begin to evacuate more than 800 workers with Moscow's contractors here, while a French journalist who was kidnapped in Iraq last weekend was freed.
Alexandre Jordanov, 40, was one of more than 40 foreigners from 13 countries seized over the past week by insurgents apparently campaigning to destabilise the one-year-old US-led occupation of Iraq, according to the coalition.
The governments of Italy and Japan pledged to keep their troops in Iraq despite the kidnapping of their nationals, but the Philippines and New Zealand have said their troop contributions are under review.