They said heavily-armed government troops aboard battle wagons -- pickup trucks mounted with machine guns -- attacked the town of Burahakaba, about 60 kilometres (38 miles) south-east of Baidoa.
The attack sparked clashes with the local militia loyal to Al Bayan Islamic Court movement, who were forced to retreat, the sources said.
"The holy warriors in Burahakaba exchanged fire with Ethiopian Tigray forces and their Somali sympathisers this morning (after which) they took control of the town," said Sheikh Mukhtar Robow, the deputy security chief in the Supreme Islamic Council of Somalia.
Robow added that the Islamic militia lost a battle wagon in the retreat. Reports of causalities remained unclear.
But a government commander said his forces met no resistance when they rode into the trading post that lies in Bay region, which is under control of the state.
"Our forces are conducting some security operations here (in Burahakaba) as well as other areas in our control. So far, we haven't met any resistance," Said Hirsi Dhere, who oversaw the seizure, told AFP by phone.
Residents, who said they saw Ethiopian troops fighting alongside Somali forces, maintained that the rivals engaged in artillery duel.
"Both sides exchanged fire. We fear that the clashes might escalate," said Hassan Mukhtar, a resident of the outpost.
Early this month, Somali government soldiers backed by Ethiopian forces briefly seized control of the town from the local militia after which they left and vowed to return.
The seizure prompted the Supreme Islamic Council of Somalia (SICS) -- the umbrella group of all Sharia courts -- to declare a holy war on Ethiopia.
Ethiopia backs the Somali transitional government that is increasingly threatened by Islamists who seized Mogadishu in June from warlords after months of fierce fighting and now control most of southern and central Somalia.
Addis Ababa has been accused of sending thousands of troops into Somalia to defend the government from feared Islamist attacks, but Prime Minister Meles Zenawi repeated this week that the only Ethiopian soldiers on Somali soil were military trainers.
Ethiopia, which is mainly Christian, is wary of the rise of the Islamists, accusing them of being "jihadists."
On Thursday, Somalia's interim president Abdullahi Yusuf Ahmed appealed for international help in dealing with the increasingly powerful movement, which he accused of operating under the "black flag" of Al Qaeda and the Taliban.
But the Islamists, who are allegedly supported by Eritrea, deny any links to Al Qaeda and instead say they have managed to restore order in areas under their control.
Analysts have warned that Somalia could became the latest theatre for proxy fighting between arch-foes Ethiopia and Eritrea, who are at odds over an unresolved border row that initially led to their 1998-2000 war.
The new clashes come as both sides are under increasing pressure to resume the third round of Arab League-mediated peace talks in Khartoum on October 30.
The talks are aimed at preventing Somalia from sliding into deeper turmoil.

Copyright AFP (Agence France-Presse), 2006