The fighting started Sunday night when Iraqi soldiers raided three neighborhoods in the city to root out the members of al-Sadr's Mahdi Army and take their weapons, reported the Associated Press.
The battles continued Monday when U.S. forces went to the aid of the Iraqi troops.
Diwaniyah is a majority Shiite city, 80 miles south of Baghdad, where the Mahdi Army has been gradually increasing in number.
Iraq's Shiite-led government has been having trouble reining in al-Sadr, whose followers hold 30 of the 275 seats in parliament and five Cabinet posts, according to the AP.
In Baghdad, meanwhile, violence has dropped by half since July when U.S.-led forces were increased there to help restore peace, U.S. military spokesman Maj. Gen. William Caldwell said Monday.
He also said Prime Minister Nouri al-Maliki would assume operational control of Iraqi armed forces next month in what he called a significant step toward Iraq taking responsibility for its security, Reuters reported.
According to Caldwell, troops had cleared 33,000 buildings, taken more than 700 weapons and detained 70 suspects during the three-week operation in Baghdad.
The daily murder rate had dropped 46 percent from July to August and car bombings were at their lowest rate for eight months, he said.
However, the announcement came as a car bomb in Baghdad killed at least 13 people and wounded dozens at a checkpoint just outside the Interior Ministry's headquarters.
The Pentagon also announced the deaths of seven American soldiers over the past two days.
