U.S. tanks encircled the city center and gunfire rang out in the alleyways near the revered shrine that the militiamen have been using as a refuge.
Al-Sadr's followers said U.S. airstrikes overnight damaged the outer walls of the shrine compound, but the U.S. military said strikes targeting militia positions south of the compound did not hit the wall, according to the Associated Press.
The uprising, which began 20 days ago, briefly ended last week when insurgents agreed to remove their weapons from the shrine. Talks between al-Sadr's aides and religious authorities over the weekend, however, broke down before Iraq's highest Shiite cleric, Grand Ayatollah Ali al-Sistani, could take control of the shrine.
But in an apparent relaxing of al-Sadr's demand that his Mahdi Army guard the mosque even after it was handed over, a top al-Sadr aide said the Shiite authorities would be responsible, Reuters reported.
"The religious establishment will be in charge of security and they should have their own security force," Sheikh Ahmed al-Sheibani, a Mahdi Army commander, told reporters outside the mosque.
Al-Sheibani said the militia would become "normal citizens" if U.S. forces returned to their bases and the southern city became stable.
Al-Sadr, whose whereabouts are unknown, has at times appeared to accept the government's demands only to reject them later.
The rebellion has spurred violence in seven other southern and central cities, including Baghdad.
The unrest also has caused oil prices to hit record highs, nearly reaching $50 a barrel last week. On Monday, the price per barrel was around $47.
Iraq's crude exports were back to normal on Monday as the country resumed pumping crude along its northern pipeline, a shipping agent said, according to Reuters.