A spokesman for al-Sadr, whose forces are locked in an intense battle inside the city with US-led troops, has already welcomed the proposal.
But Vatican spokesman Ciro Benedettini said on Tuesday the Pope was only willing to mediate if requested to do so by both sides in the conflict.
"The Holy See, obviously, is always disposed to help the parties to talk to each other and have a dialogue, on condition there exists a real will to commit to a peaceful solution to the crisis," he said.
The mediation is expected to be directly handled by the Cardinal Secretary of State Angelo Sodano, who is said to be closely following developments in Iraq.
"The Apostolic Nuncio in Baghdad [Fernando Filoni] is following developments directly, and the secretary of state remains in close contact either with him or the Chaldean patriarch [Mar Emmanuel Delly] or the country's bishops' conference," said Benedettini.
Cardinal Angelo Sodano (L) is said
to be heading the delegation
Sodano said in an interview with Italian state radio on Monday that all sides should "respect the holy character of the city. Therefore, the appeal that I make in the name of the Pope is that there is a return in any case to honest talks".
John Paul II warned US President George Bush and British Prime Minister Tony Blair against going to war in Iraq in the weeks leading up to the invasion, sending a top Vatican official to both Baghdad and Washington last year.
The vain attempt to avert the conflict, which he warned would be seen as a "clash of civilisations" between Muslims and Christians, included separate private talks at the Vatican with former Iraqi leader Saddam Hussein's foreign minister Tariq Aziz and UN Secretary General Kofi Annan.