"Attempts to win their freedom through negotiations have not led to any results," an official in a leading Shia party told Reuters on Saturday.
"The government is considering military intervention to end the standoff."
However, confusion surrounds the incident in the southern Iraqi town of al-Madain.
A spokesman for Muqtada al-Sadr, Shaikh Abd al-Hadi al-Daraji, denied that the incident had taken place and said no hostages had been taken.
"I contacted my brothers in the town who denied the news reports," al-Daraji told Aljazeera. He said the reports were meant to incite sectarian tensions.
A source at the Iraqi interior ministry said the events in al-Madain might be a tit-for-tat kidnapping of Shia after the abduction of a Sunni from the powerful Dulaimi tribe, who have a presence in the area.
Sunni fighters reportedly dynamited an empty Shia mosque in al-Madain.
Reports say a Shia mosque in the
town was blown up
Armed men blew up the Husainiyat al-Rasul al-Adham mosque during the afternoon, said a source at the interior ministry, adding that it was empty at the time.
Iraqi army special forces, seeking to regain control of the town, have surrounded al-Madain and there was a brief exchange of gunfire, an official at the defence ministry said.
Many residents have reportedly fled the town, 30km south of Baghdad, with some heading further south to predominantly Shia Kut.
"Gunmen are going around with loudspeakers demanding that all Shia leave the town," said Captain Haitham Muhammad of the Iraqi army, who fled al-Madain with several people on Friday evening to Kut.
"They have detained more than 80 people, including women and children, and they are threatening to kill them unless Shia leave."
Muhammad said many Iraqi soldiers and police officers had changed into civilian clothing and fled the mixed Sunni-Shia town on the Tigris river, built on the site of the ancient city of Ctesiphon.
A distraught Abbas Mahmud, 47, a labourer in Madain's market said: "I fled the town fearing they would kill me if I stayed."
al-Madain and other towns to the west have mixed Sunni and Shia populations. Tensions have been high between the two communities, and have worsened since the elections.