Three Iraqis were killed and seven injured in overnight fighting, hospital staff said on Thursday.
"We have three people killed and seven wounded, three of them seriously," said Hassan Toufaili a doctor at the Hakim hospital in Najaf, 160 kilometres south of Baghdad.
"Most of the casualties are civilian," said Tufaili.
The fighting broke out at about 23:00 (19:00 GMT) on Wednesday and lasted for about three hours with the sound of heavy artillery being heard at times.
The remains of one burnt vehicle stood immobile in the town square and damaged power lines littered the streets.
"I saw militia hiding in the cemetery firing at a US tank, which then responded by firing at them," said Jaber, 42, a resident.
Bullets and other projectiles were seen whizzing overnight above the city's cemetery, adjacent to the square, and a building in the area was set alight.
In Karbala, gunfire echoed from narrow streets just a few hundred metres from the Imam Hussain mosque, which sits in the centre of the city. Smoke rose from nearby, witnesses said.
Nearly 800 US soldiers have been
killed since March 2003
A Reuters TV correspondent at the scene said militiamen attacked a US Abrams tank with rocket-propelled grenades inflicting heavy damage. There was no immediate confirmation from US commanders.
The clashes followed several hours of a lull in fighting.
US forces and the militia, known as al-Mahdi Army, have skirmished repeatedly in recent days, not just in Karbala but in Najaf, to the south, and several other cities.
The US military has pledged to destroy the al-Mahdi Army, a force estimated to be 5000 strong and formed during the past year.
US soldier killed
Meanwhile, a US soldier was killed in Baghdad and a marine died of his wounds sustained in the western al-Anbar province, the US said on Thursday.
"One Task Force Baghdad soldier was killed and another was wounded when an improvised explosive device struck a convoy Wednesday in Baghdad," the US military said in a statement.
A separate statement reported that a member of the 1st Marine Expeditionary Force "died 12 May from wounds received earlier that day in al-Anbar Province while conducting security and stability operations."
The statement did not say how the US marine was wounded, saying that "the release of more details about the incident could place our personnel at greater risk."
The latest deaths brings to 777 the number of US soldiers killed since the start of the invasion of Iraq in March 2003.