A spokesman for radical cleric Moqtada al-Sadr denied that many fighters had been killed. He said 36 militiamen had been killed in several Iraqi cities from clashes that have fuelled fears of a new rebellion of radical Shia.
The fresh fighting, which still raged on Friday, marks a major challenge for the interim government of Prime Minister Iyad Allawi and appears to have destroyed a two-month-old cease-fire between US forces and Sadr's Mehdi militia.
"The number of enemy casualties is 300 KIA (killed in action)," Lieutenant Colonel Gary Johnston, operations officer for the 11th Marine Expeditionary Unit, said at a military base near the city, 160km south of Baghdad.
Johnston told reporters the Mehdi fighters were badly co-ordinated and shot at random against the heavily armed marines who were backed up by helicopter gun ships and fighter planes.
"There is fighting right now. In some ways it is not as intense as yesterday," he said.
"If you are on the ground, it makes no difference. But the marines are here and I think you know how they operate. If you kill a marine, the marines are going to fight back."
US military officials said there were indications that foreign fighters had joined the Mehdi militia. Criminal gangs were also involved, they said.
Asked about American casualties, Johnston said there were two dead and 12 wounded from the two days of fighting.
The US-appointed governor of Najaf put the militia death toll at 400, with 1,000 captured. He said he had information that 80 Iranians were fighting alongside Sadr's militia.
Sheikh Raed al Qathimi, a spokesman for Sadr, rebuffed the American version of the death toll.
"I categorically deny these American lies," he said.
British and Italian troops also fought the Mehdi militia across Shia-dominated southern Iraq - in Basra, Amara and Nassiriya - while fighting raged in Sadr City and Shoula, two Shia districts of Baghdad.
The Health Ministry said fighting in Sadr City alone had killed 20 Iraqis and wounded 114 since early on Thursday, while in Nassiriya six were dead and 13 wounded.
The flare-up of tension with radical members of Iraq's majority community comes after Shia militants rose up across south and central Iraq in April and May.
Iraq's interim government expressed confidence it would deal with the crisis.
"We have every confidence in our new government, our security forces and our allies to contain this conflict," Foreign Minister Hoshiyar Zebari said.
Yet Sadr, a young cleric with an ardent following among poor, disaffected youths, appeared keen to stop the latest fighting. Via another spokesman in Baghdad, he called for a resumption of a truce struck in June.
"We have no objections to entering into negotiations to solve this crisis," Mahmoud al-Sudani told reporters. "As I have said in the name of Sayed Sadr, we want a resumption of the truce."
While Sadr may be popular with frustrated young Shia, many of Iraq's mainstream community follow Ayatollah Ali al-Sistani, the most influential Shia cleric in Iraq who has carefully and quietly tried to keep a lid on Sadr's agitating.
In a worrying move for his followers, Sistani, a 73-year-old Iranian-born cleric, flew to London on Friday for treatment for a heart problem, sources said.
Tension has been rising in Najaf since Iraqi security forces surrounded Sadr's house earlier this week.
US marines recently replaced the US Army in Najaf and analysts have suggested the upsurge in violence is linked to the marines taking a more aggressive approach with Sadr's militia.
At the same time, attempts by the interim government to draw Sadr into the mainstream appear to have faltered, which may have prompted the cleric to redouble his militant approach.
Early on Friday F-16s, AC-130 gun ships and helicopters patrolled the skies over Najaf, covering US troops battling insurgents in and around Najaf's cemetery, the largest in the Arab world and a safe haven for militants.
Meanwhile, Najaf's governor issued a 24-hour ultimatum on Friday to the militia of radical cleric Moqtada Sadr to leave the Iraqi province or face a US military offensive, which had already claimed hundreds of lives.
"The military operations will continue unless the Mehdi Army militia leaves the province and I give them 24 hours to do that from the moment my words are broadcast," Adnan al-Zorfi told reporters.
"There is no compromise or room for another truce." Zorfi denied there had been a plot to quash Sadr's movement, saying the military action in Najaf and neighbouring areas was in response "to serious violations of the previous truce on the part of Sadr and criminal activities by his militia".
He accused the militiamen, many from outside Najaf, of turning the city's vast cemetery into a den of kidnappers, torturers and thieves.
Zorfi added that two Iraqi policemen and a national guardsman were killed and 20 wounded in the clashes.